CHAPTER 12 · · 2001-07-16Chapter Twelve Partnerships 661 Partnerships 12 CHAPTER CHAPTER...

Chapter Twelve Partnerships 661

Partnerships

1212C H A P T E R

CHAPTER OBJECTIVESAfter studying this chapter, you should be able to

1 Identify the characteristics of a partnership

2 Account for partners’ initial investments in apartnership

3 Allocate profits and losses to the partners bydifferent methods

4 Account for the admission of a new partner to thebusiness

5 Account for the withdrawal of a partner from thebusiness

6 Account for the liquidation of a partnership

7 Prepare partnership financial statements

The partnership form of business in-troduces some complexities that proprietorship avoids. How much cash should anew partner contribute to the business? How should the partners divide profitsand losses? How should a partner who leaves the firm be compensated for her orhis share of the business?

A partnership is an association of two or more persons who co-own a businessfor profit. This definition is common to the various provincial partnership acts,which tend to prescribe similar rules with respect to the organization and operationof partnerships in their jurisdiction.

Forming a partnership is easy. It requires no permission from government au-thorities and involves no legal procedures, with the exception that most provincesrequire most partnerships to register information such as the name of the partnersand the name under which the business will be carried on.1 When two persons de-cide to go into business together, a partnership is automatically formed.

A partnership brings together the assets, talents, and experience of the partners.Business opportunities closed to an individual may open up to a partnership.Suppose neither Dunn nor Grieve has enough capital individually to buy a smallbuilding for an office. They may be able to afford it together in a partnership. Theypool their talents and know-how. Their partnership thus offers clients a fuller rangeof services than either person can offer alone.

Partnerships come in all sizes. Many partnerships have fewer than ten partners.Some medical practices may have ten or more partners while some of the largest lawfirms in Canada have more than 130 partners. The largest accounting firms in

662 Part Three Accounting for Partnerships and Corporate Transactions

Bruce Dunn is a charteredaccountant in Vancouver.He received his designa-

ton as a Chartered Accountantin 1982 after articling with oneof the larger firms in Canada.Shortly after, he decided toopen his own proprietorship.Initially, he specialized in ac-counting and tax services forsmall- and medium-sized busi-nesses. His business grewquickly through the 1980s and 1990s. Bruce found that ashis practice matured, he became much more of a taxspecialist to his long-time clients.

“With the advent of computer accounting softwarepackages, more of my clients were able to perform basicaccounting duties and the skill they wanted me to pro-vide the most was in the area of taxation,” Dunn said.“The problem became that as my clients grew larger,they needed some other services, such as informationsystems consulting and treasury management consulting,that I could not provide. I was starting to lose clients to

larger, full-service firms, andmy practice was stagnant.”

Bruce learned of anothersole proprietorship, WayneGrieve, a chartered accountantwho specialized in informationsystems consulting and advi-sory services. After severalmeetings, the two CAs decidedto merge their businesses andformed a partnership.

“The partnership has beenin business for only eighteen months,” Bruce said recently,“but we can already identify benefits. We are able to offera full range of services to our clients, which allows us tocompete for clients big and small. We have both noticedthat our office operates more efficiently and we have seensome cost savings from that. An added benefit that I hadnot anticipated is that we can ‘sound ideas off each other.’With the complexities that exist today in the businessworld, the ability to discuss alternatives with a partner isalmost a necessity. Forming this partnership was the bestthing that could have happened to my business.”

THE PARTNERSHIP

1 Smyth, J.E., D.A. Soberman, and A.J. Easson, The Law and Business Administration in Canada,Ninth edition (Toronto: Pearson Education Canada Inc., 2001), pp. 580–585.

THINKING IT OVER

What are some reasons that Dunnand Grieve might form apartnership?

A: To raise more capital; to use thetalents of both partners; to expandthe business. Additional answersare possible.

Canada have from 150 to more than 500 partners.2 Exhibit 12-1 lists the 10 largestpublic accounting firms in Canada.

Characteristics of a PartnershipStarting a partnership is voluntary. A person cannot be forced to join a partnership,and partners cannot be forced to accept another person as a partner. Although thepartnership agreement may be oral, a written agreement between the partners re-duces the chance of a misunderstanding. The following characteristics distinguishpartnerships from sole proprietorships and from corporations.

The Written Partnership AgreementA business partnership is like a marriage. To be successful, the partners must co-operate. However, business partners do not vow to remain together for life. Tomake certain that each partner fully understands how the partnership operates andto lower the chances that any partner might misunderstand how the business isrun, partners may draw up a partnership agreement. This agreement is a contractbetween the partners, so transactions under the agreement are governed by con-tract law. The provincial legislatures in Canada have passed their respective versionsof a partnership act, the terms of which apply in the absence of a partnership agree-ment or in the absence of particular matters in the partnership agreement.3

The partnership agreement should make the following points clear:1. Name, location, and nature of the business2. Name, capital investment, and duties of each partner3. Method of sharing profits and losses among the partners4. Withdrawals of assets allowed to the partners5. Procedures for settling disputes among the partners6. Procedures for admitting new partners7. Procedures for settling with a partner who withdraws from the business8. Procedures for removing a partner who will not withdraw or retire from the

partnership voluntarily9. Procedures for liquidating the partnership—selling the assets, paying the lia-

bilities, and disbursing any remaining cash to the partners


NumberRank Revenue of Partners/1999 Firm (Millions) Principals

1 PricewaterhouseCoopers LLP (June 1999)* $845 5342 Deloitte & Touche LLP (August 1999) 750 5223 KPMG LLP (September 1999) 735 5484 Ernst & Young LLP (September 1999) 616 4125 Grant Thornton Canada (Decemb er 1999) 228 3686 Arthur Andersen LLP (August 1999) 203 1557 BDO Dunwoody LLP (December 1999) 172 2878 Collins Barow/Mintz & Partners (January 2000)** 56 1199 Richter Usher & Vineberg (February 2000) 54 5510 HLB/Schwartz Levitsky Feldman (January 2000) 38 62

Source: “Canada Largest Corporations,” National Post Business, June 2000, p. 164.* Formed by the combination of Price Waterhouse and Coopers & Lybrand in fiscal 1999.

** Mintz & Partners joined Collins Barrow in July 1999.

EXHIBIT 12-1

The Ten Largest AccountingPartnerships in Canada (datagiven are as of the dateshown in brackets)

2 “Canada’s Largest Corporations,” National Post Business, June 2000, p. 164.3 Smyth, J.E., D.A. Soberman, and A.J. Easson, The Law and Business Administration in Canada, Ninth edi-

tion. (Toronto: Pearson Education Canada Inc., 2001), pp. 590–597.

PricewaterhouseCoopers LLPwww.pwcglobal.com

Deloitte & Touche LLPwww.deloitte.ca

KPMG LLPwww.kpmg.ca

Ernst & Young LLPwww.eycan.com

Grant Thornton Canadawww.grantthornton.ca

Arthur Andersen LLPwww.arthurandersen.ca

BDO Dunwoody LLPwww.bdo.ca

Collins Barrow/Mintz &Partnerswww.collinsbarrow.com

Richter, Usher & Vineberg LLPwww.richter.ca

HLB/Schwartz LevitskyFeldman LLPwww.slf.ca

A partnership is not required tohave a formal written agreement.But a written agreement preventsconfusion as to the sharing ofprofits and losses, partners’responsibilities, admission of newpartners, how the partnership willbe liquidated, and so on. A writtenagreement does not precludediscord, however.

KEY POINT

OBJECTIVE 1Identify the characteristics of apartnership

As partners enter and leave the business, the old partnership is dissolved and anew partnership is formed. Drawing up a new agreement for each new partner-ship may be expensive and time-consuming.

Limited LifeA partnership has a life limited by the length of time that all partners continue toown the business. If Bruce Dunn of the chapter-opening story withdraws from thebusiness, the partnership of Dunn & Grieve will cease to exist. A new partnershipmay emerge to continue the same business, but the old partnership will have been dis-solved. Dissolution is the ending of a partnership. The addition of a new partnerdissolves the old partnership and creates a new partnership. Large parnterships suchas PricewaterhouseCoopers retain the firm name even after partners resign from thefirm.

Mutual AgencyMutual agency in a partnership means that every partner can bind the business toa contract within the scope of the partnership’s regular business operations. If BruceDunn enters into a contract with a person or another business to provide service, thenthe firm of Dunn & Grieve—not only Dunn—is bound to provide that service. IfDunn signs a contract to purchase lawn services for his home, however, the part-nership would not be bound to pay because the lawn service is a personal matter forDunn. It is not a regular business operation of the partnership.

Unlimited LiabilityEach partner has an unlimited personal liability for the debts of the partnership.When a partnership cannot pay its debts with business assets, the partners mustuse their personal assets to meet the debt. Proprietors also have unlimited personalliability for the debts of their business.

Suppose the Dunn & Grieve firm had an unsuccessful year, and the partner-ship’s liabilities exceed its assets by $20,000. Dunn and Grieve must pay this amountwith their personal assets. Because each partner has unlimited liability, if a partner isunable to pay his or her part of the debt, the other partner (or partners) must makepayment. If Grieve can pay only $5,000 of the liability, Dunn must pay $15,000.

Unlimited liability and mutual agency are closely related. A dishonest partner ora partner with poor judgment may commit the partnership to a contract underwhich the business loses money. In turn, creditors may force all the partners to paythe debt from their personal assets. Hence, a business partner should be chosenwith great care.

Partners can avoid unlimited personal liability for partnership obligations byforming a limited partnership. In this form of business organization, one or more ofthe general partners assumes the unlimited liability for business debts. In addition,there is another class of owners, limited partners, who can lose only as much astheir investment in the business. In this sense, limited partners have limited liabil-ity similar to the limited liability that shareholders in a corporation have.

Co-ownership of PropertyAny asset—cash, inventory, machinery, and so on—that a partner invests into thepartnership becomes the joint property of all the partners. Also, each partner has aclaim to his or her share of the business’s profits.

No Partnership Income TaxesA partnership pays no income tax on its business income. Instead, the net incomeof the partnership is divided, and becomes the taxable income of the partners.Suppose Dunn & Grieve earned net income of $150,000, shared equally by partners


Note that when a partner leaves apartnership, it dissolves and itsbooks are closed. If the remainingpartners want to continue aspartners, they form a newpartnership with a new set ofbooks. Dissolution does notrequire liquidation; that is, theassets need not be sold to outsideparties.

LEARNING TIP

Since all partners are personallyliable for any debt of the business,it is extremely important to choosea partner carefully. This is onereason some investors/partnersprefer the limited partnership formof business organization.

KEY POINT

A personal investment of assets ina partnership becomes the jointproperty of all the partners.

KEY POINT

Dunn and Grieve. Dunn & Grieve would pay no income tax as a business entity.However, Dunn and Grieve would pay income tax as individuals on their $75,000shares of partnership income.

Partners’ Owner’s Equity AccountsRecall from Chapter 1, page 12, that owner’s equity for a proprietorship has only oneaccount, entitled “Capital.” For example, when Bruce Dunn had his own saccountingpractice, owner’s equity would have been the single account Bruce Dunn, Capital.

Accounting for a partnership is much like accounting for a proprietorship. Werecord buying and selling goods and services, collecting, and paying cash for apartnership just as we do for a proprietorship. But, because a partnership has morethan one owner, the partnership must have more than one owner’s equity account.Every partner in the business—whether the firm has two or two hundred part-ners—has an individual owner’s equity account. Often these accounts carry thename of the particular partner and the word capital. For example, the owner’s equityaccount for Bruce Dunn would read “Bruce Dunn, Capital.” Just as a sole proprietorhas a drawings or withdrawal account (a temporary account), each partner in apartnership has a withdrawal account. If the number of partners is large, the gen-eral ledger may contain the single account Partners’ Capital or Owners’ Equity. Asubsidiary ledger can be used for individual partner accounts.

Exhibit 12-2 lists the advantages and disadvantages of partnerships (comparedto proprietorships and corporations).

Types of PartnershipsThere are two basic types of partnerships: general and limited.

General PartnershipsA general partnership is the basic form of partnership organization. Each partner-ship is an owner of the business with all the privileges and risks of ownership. Thegeneral partners share the profits, losses, and the risks of the business. The part-nership reports its income to governmental tax authorities (C anada Customs andRevenue Agency, or CCRA), but the partnership pays no income tax. The profitsand losses of the partnership pass through the business to the partners, who then paypersonal income tax on their income.


EXHIBIT 12-2

Advantages andDisadvantages ofPartnerships

Partnership Advantages

Versus Proprietorships:

1. Can raise more capital.

2. Brings together the expertise ofmore than one person

3. 1+1>2 in a good partnership. If thepartners work well together, theycan achieve more than by workingalone.

Versus Corporations:4. Less expensive to organize than a

corporation, which requires articlesof incorporation from a province orthe federal government.

5. Fewer governmental regulationsand restrictions than a corporation.

Partnership Disadvantages

1. Partnership agreement may bedifficult to formulate. Each time anew partner is admitted or a part-ner leaves the partnership, thebusiness needs a new partnershipagreement.

2. Relationships among partnersmay be fragile.

3. Mutual agency and unlimitedpersonal liability create personalobligations for each partner.

A partnership is really a "multipleproprietorship." Most features of aproprietorship also apply to apartnership—in particular, limitedlife and unlimited liability.

LEARNING TIP

Limited PartnershipsA limited partnership has at least two classes of partners. There must be at least onegeneral partner, who takes primary responsibility for the management of the business.The general partner also takes the bulk of the risk of failure in the event of the part-nership goes bankrupt (liabilities exceed assets). In some limited partnerships, suchas real-estate limited partnerships, the general partner often invests little cash inthe business. Instead, the general partner’s contribution is her or his skill in managingthe organization. Usually, the general partner is the last owner to receive a shareof partnership profits and losses. But the general partner may earn all excess prof-its after satisfying the limited partners’ demands for income.

The limited partners are so named because their personal obligation for the part-nership’s liabilities is limited to the amount they have invested in the business.Usually, the limited partners have invested the bulk of the partnership’s asset andcapital. They therefore usually have the first claim to partnership profits and losses,but only up to a specified limit. In exchange for their limited liability, their poten-tial for profits usually has a limit as well.

Most of the large public accounting firms in Canada are now organized as lim-ited liability partnerships (LLPs), which means that each partner’s personal lia-bility for the business’s debts is limited to a certain dollar amount. An example isPricewaterhouseCoopers LLP. The LLP must carry an adequate amount of mal-practice insurance to protect the public.

Initial Investments by PartnersLet’s examine the start up of a partnership. We will see how to account for the mul-tiple owner’s equity accounts of the partners and learn how they appear on thebalance sheet.

Partners in a new partnership may invest assets and their related liabilities inthe business. These contributions are entered in the books by recording the assets andliabilities, in the same way as proprietorships record them, at their agreed-uponvalues. Each person’s net contribution (assets minus liabilities) is credited to theowner’s equity account for that person. Often the partners hire an independentfirm to appraise their assets and liabilities at current market value at the time apartnership is formed. This outside evaluation assures an objective valuation forwhat each partner brings into the business.

Assume Karen Edwards and Linda McLean form a partnership to develop andsell computer software. The partners agree on the following values based on an in-dependent appraisal:

Edwards’ contributions

• Cash, $20,000; inventory, $140,000; and accounts payable, $170,000 (The ap-praiser believes that the current market values for these items equalEdwards’ book values.)

• Accounts receivable, $60,000, less allowance for doubtful accounts of$10,000

• Computer equipment: cost, $800,000; accumulated amortization, $200,000;current market value, $450,000

McLean’s contributions

• Cash, $10,000• Computer software: cost, $36,000; current market value, $200,000


OBJECTIVE 2Account for partners’ initialinvestment in a partnership

The partnership records receipts of the partners’ initial investments at the currentmarket values of the assets and liabilities because, in effect, the partnership is buy-ing the assets and assuming the liabilities at their current market values. The part-nership entries are as follows:

Edwards’ investment

2003June 1 Cash...................................................................... 20,000

Accounts Receivable .......................................... 60,000Inventory ............................................................. 140,000Computer Equipment........................................ 450,000

Allowance for Doubtful Accounts .............. 10,000Accounts Payable .......................................... 170,000Karen Edwards, Capital................................ 490,000

To record Edwards’ investment in the part-nership ($670,000 – $180,000).

McLean’s investment

2003June 1 Cash...................................................................... 10,000

Computer Software............................................ 200,000Linda McLean, Capital ................................. 210,000

To record McLean’s investment in thepartnership.

The initial partnership balance sheet reports these amounts as shown in Exhibit 12-3.Note that the asset and liability sections on the balance sheet are the same for aproprietorship and a partnership.


STOP & THINK

How could a partner allow the partnership to use a personal asset, such as a car ormoney, without losing his or her claim to that asset?

Answer: The partner could lease the car to the partnership. If the partnership were liq-uidated, the car would have to be returned to its owner. The partner could also lendmoney to the partnership instead of investing it. Upon liquidation, the partnershipwould have to repay the loan to the lending partner before any distribution of capital tothe partners.

EXHIBIT 12-3

Partnership Balance Sheet

AssetsCash............................... $ 30,000Accounts receivable..... $60,000

Less: Allowance fordoubtful accounts.... 10,000 50,000

Inventory ...................... 140,000Computer equipment . 450,000Computer software ..... 200,000

Total assets.................... $870,000

LiabilitiesAccounts payable..................... $170,000

CapitalKaren Edwards, capital ........... 490,000Linda McLean, capital ............. 210,000Total capital............................... 700,000Total liabilities

and capital............................ $870,000

EDWARDS AND McLEANBalance SheetJune 1, 2003

The major difference in accountingfor a proprietorship versus apartnership is the number ofcapital and drawing accounts. Thepartnership balance sheet shows aseparate capital account for eachpartner, and there is a separatedrawing account for each partner.The asset and liability sections onthe balance sheet and the incomestatement are the same for aproprietorship and a partnership.

KEY POINT

Sharing Partnership Profits and LossesAllocating profits and losses among partners is one of the most challenging aspectsof managing a partnership and can be a major source of disputes. Any division ofprofits and losses is allowed as long as the partners agree and it is in the partnershipagreement. If the partners have not drawn up an agreement, or if the agreementdoes not state how the partners will divide profits and losses, then, by law, thepartners must share profits and losses equally. If the agreement specifies a methodfor sharing profits but not losses, then losses are shared in the same proportion asprofits. For example, a partner receiving 75 percent of the profits would likewise ab-sorb 75 percent of any losses.

In some cases, an equal division is not fair. One partner may perform more workfor the business than the other partner, or one partner may make a larger capitalcontribution. In the preceding example, Linda McLean might agree to work longerhours for the partnership than Karen Edwards in order to earn a greater share ofprofits. Edwards could argue that she should receive more of the profits becauseshe contributed more net assets ($490,000) than McLean did ($210,000). McLean


Accounting and the -World

The Lively Life of a Dot.com Partnership

Founding partners say that starting up a business is the life. Sleep is scant andcash is low, but hopes and energy run high. Some Internet businesses have startedwith nothing more than enthusiastic partners and a winning idea.

The story of Yahoo! founders Jerry Yang and David Filo is now legend. In 1994,the two Stanford University graduate students created a way to categorize Websites. Their guide, names Yahoo!, was the first place for Web browsers to find siteseasily. Now Yahoo! is a global Internet communications, commerce, and media com-pany with over 2,000 employees.Yahoo! has a global Web network of 21 propertiesand offices in the United States, Canada, Europe, Asia, and Latin America.

Founded in 1999 by 19-year-old Shawn Fanning and 20-year-old Sean Parker,Napster, created software that lets people trade music files on the Internet forfree. In almost no time, the company turned the music industry upside down. Twentymillion users downloaded the free software in just seven months, and Fortunemagazine commended the company for pioneering one of the hottest businessconcepts of our time: peer-to-peer information sharing. Napster is so successful thatsome members of the music industry have effectively put the organization out ofbusiness.

In 1994, Todd Krizelman and Stephen Paternot, both 25 and at CornellUniversity, created an online community where participants could go to find news,discussion forums, and products, called theglobe.com. Krizelman and Paternotdrained their bank accounts and lived off credit cards, and recruited employees inthe student lounge, paying them with Domino pizza. Four years later, theglobe.combrought in $27 million in an initial public stock offering, and the former dorm buddiesare now joint Chief Executive Officers (CEOs).

Based on: [Yahoo!] Information from http://join.yahoo.com/cheif.html andhttp://join.yahoo.com/overview.html. [Napster] Chuck Phillips, “Company Town; THE BIZ Q & A; Humming a Hopeful Tune at Napster,” The Lost Angeles Times, July 19, 2000, p. 1.Amy Kover, “Napster: The Hot Idea of the Year,” Fortune, June 26, 2000, pp. 128–136.[theglobe.com] Stephanie Armour, “Tech Grads Loving Life: Pizza, Jeans, Happy Hour,”USA Today, June 21, 1999, p. 01B.

OBJECTIVE 3Allocate profits and losses to the partners by differentmethods

THINKING IT OVER

Notice the credits to Capital in thetwo journal entries on June 1 onpage 667. Must the partnerscontribute equal amounts?

A: No, the partners can agree onthe amounts invested. Theamounts invested do notnecessarily determine how profitsand losses will be divided.

might contend that her computer software programis the partnership’s most important asset, and thather share of the profits should be greater thanEdwards’ share. Arriving at fair sharing of profitsand losses in a partnership may be difficult. We nowdiscuss the options available in determining partners’shares of profits and losses.

Sharing Based on a Stated FractionPartners may state a particular fraction of the totalprofits and losses each individual partner will share.Suppose the partnership agreement of Sarah Cagleand Bill Elias allocates two-thirds of the businessprofits and losses to Cagle and one-third to Elias. If net income for the year is$270,000, and all revenue and expense accounts have been closed, the IncomeSummary account has a credit balance of $270,000:

Income Summary

Bal. 270,000

The entry to close this account and allocate the profit to the partners’ capital ac-counts is

Dec. 31 Income Summary.................................................. 270,000Sarah Cagle, Capital ........................................ 180,000Bill Elias, Capital .............................................. 90,000

To allocate net income to partners. (Cagle: $270,000 × 2⁄3; Elias: $270,000 × 1⁄3)

Consider the effect of this entry. Does Cagle get cash of $180,000 and Elias cashof $90,000? No. The increase in the capital accounts of the partners cannot be linkedto any particular asset, including cash. Instead, the entry indicates that Cagle’sownership in all the assets of the business increased by $180,000 and Elias’s by$90,000.

If the year’s operations resulted in a net loss of $132,000, the Income Summary ac-count would have a debit balance of $132,000. In that case, the closing entry to allocate the loss to the partners’ capital accounts would be

Dec. 31 Sarah Cagle, Capital............................................. 88,000Bill Elias, Capital................................................... 44,000

Income Summary ............................................ 132,000To allocate net loss to partners.(Cagle: $132,000 × 2⁄3; Elias: $132,000 × 1⁄3)

Just as profit of $270,000 did not mean that the partners received cash of $180,000and $90,000, so the loss of $132,000 does not mean that the partners must contributecash of $88,000 and $44,000. A profit or loss will increase or decrease each partner’scapital account, but cash may not change hands.

Sharing Based on Capital ContributionsProfits and losses are often allocated in proportion to the partners’ capital contri-butions in the business. Suppose Jim Antoine, Erica Barber, and Tony Culomovic arepartners in ABC Company. Their capital accounts have the following balances at theend of the year, before the closing entries:


I find that allocating profits and losses topartners can be confusing. However, theexamples given in this chapter are very clear,and I used the Working It Out questions in themargin for extra practice. (And having theanswers for them helps too!)

Diane S., Kingston

Student to Student

Ash, Black, and Cole share profitsin a 30:40:30 ratio. Compute eachpartner’s share of net income if thepartnership income is $100,000.

A:Ash:($100,000 � 30%) = $30,000Black:($100,000 � 40%) = 40,000Cole:($100,000 � 30%) = 30,000

$100,000

WORKING IT OUT

Ash, Black, and Cole share profitson the basis of capital accountbalances of $20,000, $40,000, and$140,000, respectively. Computeeach partner’s share of net incomeif the partnership net income is$100,000.

A:Ash:($20,000/$200,000 �$100,000) = $ 10,000Black:($40,000/$200,000 �$100,000) = 20,000Cole:($140,000/$200,000 �$100,000) = 70,000

$100,000

WORKING IT OUT

Jim Antoine, Capital....................................................................................... $ 60,000Erica Barber, Capital....................................................................................... 90,000Tony Culomovic, Capital............................................................................... 75,000Total capital balances ..................................................................................... $225,000

Assume that the partnership earned a profit of $180,000 for the year. To allocatethis amount based on capital contributions, each partner’s percentage share of thepartnership’s total capital balance must be computed. We simply divide each part-ner’s contribution by the total capital amount. These figures, multiplied by the$180,000 profit amount, yield each partner’s share of the year’s profits:

Antoine: ($60,000/$225,000) × $180,000 = $ 48,000Barber: ($90,000/$225,000) × $180,000 = 72,000Culomovic: ($75,000/$180,000) × $180,000 = 60,000

Net income allocated to partners = $180,000

The closing entry to allocate the profit to the partners’ capital accounts is

Dec. 31 Income Summary ............................................... 180,000Jim Antoine, Capital...................................... 48,000Erica Barber, Capital...................................... 72,000Tony Culomovic, Capital.............................. 60,000

To allocate net income to partners.

After this closing entry, the partners’ capital balances are

Jim Antoine, Capital ($60,000 + $48,000)...................................................... $108,000Erica Barber, Capital ($90,000 + $72,000)...................................................... 162,000Tony Culomovic, Capital ($75,000 + $60,000).............................................. 135,000Total capital balances after allocation of net income.................................. $405,000

Sharing Based on Capital Contributions and on ServiceOne partner, regardless of his or her capital contribution, may put more work intothe business than the other partners. Even among partners who log equal servicetime, one person’s superior experience and knowledge may command a greatershare of income. To reward the harder-working or more valuable person, theprofit-and-loss-sharing method may be based on a combination of contributed cap-ital and service to the business. Most law firms take service into account in deter-mining partner compensation.

Assume Sheila Randolph and Carolyn Scott formed a partnership in whichRandolph invested $60,000 and Scott invested $40,000, a total of $100,000. Scott de-votes more time to the partnership and earns the larger salary. Accordingly, thetwo partners have agreed to share profits as follows:

1. The first $50,000 of partnership profits is to be allocated based on partners’ cap-ital contributions to the business.

2. The next $60,000 of profits is to be allocated based on service, with Randolphreceiving $24,000 and Scott receiving $36,000.

3. Any remaining amount is allocated equally.

If net income for the first year is $125,000, the partners’ shares of this profit arecomputed as follows:


THINKING IT OVER

Under what circumstances woulda partner make an initialcontribution of a liability?

A: A partner could contribute anasset with a liability attached to it.For example, a partner couldcontribute a mortgaged building tothe partnership. In transferring thebuilding to the partnership, thepartner would also be transferringthe note payable (a liability), aslong as the original lender agreesto the transaction.

Ash, Black, and Cole have capitalbalances of $20,000, $40,000, and$140,000, respectively. Thepartners share profits and lossesas follows: (1) The first $50,000 is allocatedon the basis of partners’ capitalbalances. (2) The next $38,000 is allocatedon the basis of service, with Ash,Black, and Cole receiving $10,000,$12,000, and $16,000,respectively. (3) The remainder is dividedequally.

Compute each partner’s share ofnet income if the partnership earns$100,000.

A:Ash:($20,000/$200,000 � $50,000) +$10,000 + $4,000* = $19,000Black:($40,000/$200,000 � $50,000) +$12,000 + $4,000* = $26,000Cole:($140,000/$200,000 � $50,000) +$16,000 + $4,000* = $55,000

*Remainder shared equally:$100,000 – $50,000 – $38,000 = $12,000$12,000 / 3 = $4,000

WORKING IT OUT

Randolph Scott Total

Total net income................................................................ $125,000Sharing of first $50,000 of net income,

based on capital contributions:Randolph ($60,000/$100,000 × $50,000)..................... $30,000Scott ($40,000/$100,000 × $50,000).............................. $20,000

Total ........................................................................... 50,000Net income remaining for allocation ............................. 75,000Sharing of next $60,000, based on service:

Randolph........................................................................ 24,000Scott................................................................................. 36,000

Total ........................................................................... 60,000Net income left for allocation.......................................... 15,000Remainder shared equally:

Randolph ($15,000 ×1⁄2) ............................................... 7,500

Scott ($15,000 ×1⁄2)........................................................ 7,500

Total ........................................................................... 15,000Net income left for allocation.......................................... $ -0- bNet income allocated to the partners............................. $61,500 $63,500 $125,000

On the basis of this allocation, the closing entry is

Dec. 31 Income Summary................................................ 125,000Sheila Randolph, Capital.............................. 61,500Carolyn Scott, Capital ................................... 63,500

To allocate net income to partners.

Sharing Based on “Salaries” and InterestPartners may be rewarded for their service and their capital contributions to thebusiness in other ways. In one sharing plan, the partners are allocated “salaries”(which are predetermined sums to be withdrawn, not employee salaries) plus intereston their capital balances. Assume Edward Massey and Pierre Vanier form an oil-exploration partnership. At the beginning of the year, their capital balances are$80,000 and $100,000 respectively. The partnership agreement allocates annual“salary” of $43,000 to Massey and $35,000 to Vanier. After these amounts are allocated,each partner earns 8 percent interest on his beginning capital balance. Any remain-ing net income is divided equally. Partnership profit of $96,000 for 2003 will be al-located as follows:

Massey Vanier Total

Total net income............................................................ $96,000First, “salaries”:

Massey........................................................................ $43,000Vanier.......................................................................... $35,000

Total ....................................................................... 78,000Net income remaining for allocation ......................... 18,000Second, interest on beginning capital balances:

Massey ($80,000 × 0.08) ............................................ 6,400Vanier ($100,000 × 0.08)............................................ 8,000

Total ....................................................................... 14,400Net income remaining for allocation ......................... 3,600Third, remainder shared equally:

Massey ($3,600 ×1⁄2) ................................................. 1,800

Vanier ($3,600 ×1⁄2)................................................... 1,800

Total ....................................................................... 3,600Net income remaining for allocation ......................... $ -0- bNet income allocated to the partners......................... $51,200 $44,800 $96,000


THINKING IT OVER

What factors influence the wayprofits and losses are shared?

A: Each partner’s initialcontribution of assets andliabilities; the fair market value ofthe assets contributed; the timeeach partner will devote to thebusiness; the skills, abilities,reputation, clients, and such thateach partner contributes.

In the preceding illustration, net income exceeded the sum of “salary” and interest.If the partnership profit is less than the allocated sum of “salary” and interest, anegative remainder will occur at some stage in the allocation process. Even so, thepartners use the same method for allocation purposes. For example, assume thatMassey and Vanier Partnership earned only $82,000 in 2003.

Massey Vanier Total

Total net income............................................................ $82,000)First, “salaries”:

Massey........................................................................ $43,000)Vanier.......................................................................... $35,000)

Total ....................................................................... 78,000)Net income remaining for allocation......................... 4,000)Second, interest on beginning capital balances:

Massey ($80,000 × 0.08) ............................................ 6,400)Vanier ($100,000 × 0.08)............................................ 8,000)

Total ....................................................................... 14,400)Net income remaining for allocation......................... (10,400)Third, remainder shared equally:

Massey ($10,400 × 1⁄2)................................................. (5,200)Vanier ($10,400 × 1⁄2) .................................................. (5,200)

Total ....................................................................... (10,400)Net income remaining for allocation......................... $ -0- )Net income allocated to the partners......................... $44,200) $37,800) $82,000)

A net loss would be allocated to Massey and Vanier in the same manner out-lined for net income. The sharing procedure would begin with the net loss, andthen allocate “salary,” interest, and any other specified amounts to the partners.

For example, assume that Massey and Vanier Partnership had a loss of $12,000in 2003.

Massey Vanier Total

Total net income............................................................ ($12,000)First, “salaries”:

Massey........................................................................ $43,000)Vanier.......................................................................... $35,000)

Total ....................................................................... 78,000)Net income (loss) remaining for allocation............... (90,000)Second, interest on beginning capital balances:

Massey ($80,000 × 0.08) ............................................ 6,400)Vanier ($100,000 × 0.08)............................................ 8,000)

Total ....................................................................... 14,400)Net income (loss) remaining for allocation............... (104,400)

Third, remainder shared equally:Massey ($104,400 × 1⁄2)............................................... (52,200)Vanier ($104,400 × 1⁄2) ................................................ (52,200)

Total ....................................................................... (104,400)Net income remaining for allocation........................... $ -0- b)Net income (loss) allocated to the partners ................ ($2,800) ($9,200) ($12,000)

We see that partners may allocate profits and losses based on a stated fraction,contributed capital, service, interest on capital, or any combination of these factors.Each partnership shapes its profit-and-loss-sharing ratio to fit its own needs.


Ash, Black, and Cole have capitalbalances of $20,000, $40,000, and$140,000, respectively. Thepartners share profits and lossesas follows: (1) Ash and Cole receive "salaries"of $12,000 and $14,000,respectively. (2) Interest of 10% is paid on thecapital balances. (3) The remainder is dividedequally.

Compute each partner’s share ofnet income if the partnership earns$100,000.

A:Ash:$12,000 + (10% � $20,000)+ $18,000* = $32,000

Black: (10% � $40,000)+ $18,000* = $22,000

Cole: $14,000 + (10% � $140,000)+ $18,000* = $46,000

*Remainder = [$100,000 – $12,000 – $14,000 – (10% � $200,000)] = $54,000$54,000/3 = $18,000

WORKING IT OUT

REAL WORLD EXAMPLE

In some large partnerships, a"units" system of profit and lossallocation is used. Each partner isawarded a particular number ofunits, which becomes thenumerator in the fraction used forallocation. The total number ofunits awarded is the denominatorin the fraction. The units methodcan allow a partnership tocontinue even as partners enterand withdraw from the partnershipif unit formulas (rather thanpartner names) are a part of thepartnership agreement.

Partner Withdrawals (Drawings) of Cash and Other Assets

Like anyone else, partners need cash for personal living expenses. Partnershipagreements usually allow partners to withdraw cash or other assets from the busi-ness. These withdrawals are sometimes called drawings, and are recorded in a sep-arate Withdrawals or Drawings account for each partner. (Drawings from apartnership are recorded exactly as for a proprietorship.) Assume that both EdwardMassey and Pierre Vanier are allowed a monthly withdrawal of $5,000. The part-nership records the March 2003 withdrawal with this entry:

Mar. 31 Edward Massey, Withdrawals .............................. 5,000Pierre Vanier, Withdrawals.................................... 5,000

Cash ..................................................................... 10,000Monthly partner withdrawals of cash.

During the year, each partner’s withdrawal account accumulates 12 such amounts,a total of $60,000 ($5,000 × 12). At the end of the period, the general ledger shows thefollowing account balances immediately after net income has been closed to thepartners’ capital accounts. Assume the January 1, 2003, balances for Massey andVanier shown below, and that $82,000 of profit has been allocated on the basis of theillustration on page 672.


STOP & THINK

Are these “salaries” and interest amounts business expenses in the usual sense? Explainyour answer.

Answer: No, partners do not work for their own business to earn a salary, as an em-ployee does. They do not loan money to their own business to earn interest. Their goal isfor the partnership to earn a profit. Therefore, “salaries” and interest in partnership agree-ments are simply ways of expressing the allocation of profits and losses to the partners. Forexample, the “salary” component of partner income rewards service to the partnership.The interest component rewards a partner’s investment of cash or other assets in thebusiness. But the partners’ “salary” and interest amounts are not salary expense and in-terest expense in the partnership’s accounting or tax records.

The withdrawal accounts must be closed at the end of the period (as must be donefor a proprietorship). The closing entry credits each partner’s Withdrawals accountand debits each partner’s Capital account. The amount of the withdrawal does not

Edward Massey, Capital Pierre Vanier, Capital

Jan. 1, 2003 Bal. 80,000 Jan. 1, 2003 Bal. 100,000Dec. 31, 2003 Dec. 31, 2003

Net income 44,200 Net income 37,800

Edward Massey, Withdrawals Pierre Vanier, Withdrawals

Dec. 31, 2003 Bal. 60,000 Dec. 31, 2003 Bal. 60,000

REAL WORLD EXAMPLE

According to the Income Tax Act,partners are taxed on their shareof partnership income, not on theamount of their withdrawals.

depend on the partnership’s income or loss for the year. In fact, it is possible for a part-ner to withdraw more than the balance in the capital account if, for example, profitswere expected to be higher than they proved to be and withdrawals were made in an-ticipation of these high profits. This situation can only occur if the partnership has thecash required for the withdrawal and the other partners agree with the withdrawaland the ending capital balance.

Admission of a PartnerA partnership lasts only as long as its partners remain in the business. The addition ofa new member or the withdrawal of an existing member dissolves the partnership.We turn now to a discussion of how partnerships dissolve—and how new partner-ships arise.

Often a new partnership is formed to carry on the former partnership’s business.In fact, the new partnership may choose to retain the dissolved partnership’s name.PricewaterhouseCoopers LLP, for example, is an accounting and consulting firmthat retires and admits partners during the year. Thus the former partnership dissolvesand a new partnership begins many times. The business, however, retains the nameand continues operations. Other partnerships may dissolve and then re-form undera new name. Let’s look at the ways that a new member may gain admission into anexisting partnership.

Admission by Purchasing a Partner’s InterestA person may become a member of a partnership by gaining the approval of theother partner (or partners) for entrance into the firm, and by purchasing a presentpartner’s interest in the business. Let’s assume that Stephi Fisher and Carlo Levesquehave a partnership that carries these figures:

Cash ....................................... $ 80,000 Total liabilities...................... $240,000Other assets .......................... 720,000 Stephi Fisher, capital ........... 220,000

Carlo Levesque, capital ...... 340,000Total liabilities

Total assets............................ $800,000 and capital....................... $800,000

Business is so successful that Fisher receives an offer from Linda Dynak, an out-side party, to buy her $220,000 interest in the business for $300,000. Fisher agrees tosell out to Dynak, and Levesque approves Dynak as a new partner. The firm recordsthe transfer of capital interest in the business with this entry:

Apr. 16 Stephi Fisher, Capital.......................................... 220,000Linda Dynak, Capital .................................... 220,000

To transfer Fisher’s equity in the business toDynak.

The debit side of the entry closes Fisher’s capital account because she is no longera partner in the firm. The credit side opens Dynak’s capital account because Fisher’sequity has been transferred to Dynak. The entry amount is Fisher’s capital balance($220,000) and not the $300,000 price that Dynak paid Fisher to buy into the business.The full $300,000 goes to Fisher, including the $80,000 difference between her capitalbalance and the price received from Dynak. In this example, the partnership doesnot receive cash because the transaction was between Dynak and Fisher, not be-tween Dynak and the partnership. Suppose Dynak pays Fisher less than Fisher’s cap-ital balance. The entry on the partnership books is not affected. Fisher’s equity istransferred to Dynak at book value ($220,000).

The old partnership has dissolved. Levesque and Dynak draw up a new part-nership agreement, with a new profit-and-loss-sharing ratio, and continue business


OBJECTIVE 4Account for the admission of anew partner to the business

Ted and Fred are partners withcapital balances of $32,000 and$48,000, respectively. Profits andlosses are shared on the basis ofcapital balances. Ann offers Fred$120,000 for his interest in thebusiness. What is the entry torecord the transfer of capital?

A:Fred, Capital ......... 48,000

Ann, Capital ...... 48,000

WORKING IT OUT

The profit or loss on the sale of apartnership interest belongspersonally to the partner sellingthe interest and will not appear onthe partnership’s books.

KEY POINT

operations. If Levesque does not accept Dynak as a partner, the Fisher and Levesquepartnership would be dissolved, and Dynak would be unable to buy Fisher’s interest.

Admission by Investing in the PartnershipA person may be admitted as a partner by investing directly in the partnership ratherthan by purchasing an existing partner’s interest. The new partner contributes assets—for example, cash, inventory, or equipment—to the business. Assume that the part-nership of Robin Ingel and Michael Jay has the following assets, liabilities, andcapital:

Cash ...................................... $ 30,000 Total liabilities ...................... $ 90,000Other assets.......................... 300,000 Robin Ingel, capital.............. 105,000

Michael Jay, capital .............. 135,000Total liabilities

Total assets ...................... $330,000 and capital ....................... $330,000

Laureen Kahn offers to invest equipment and land (Other assets) with a marketvalue of $120,000 to persuade the existing partners to take her into the business. Ingeland Jay agree to dissolve the existing partnership and to start up a new business,giving Kahn one-third interest—[$120,000/($105,000 + $135,000 + $120,000) = 1⁄3]—inexchange for the contributed assets. Notice that Kahn is buying into the partnershipat book value because her one-third investment ($120,000) equals one-third of thenew partnership’s total capital ($360,000). The entry to record Kahn’s investment is

July 18 Other Assets ......................................................... 120,000Laureen Kahn, Capital................................... 120,000

To admit L. Kahn as a partner with aone-third interest in the business.

After this entry, the partnership books show:

Cash ....................................... $ 30,000 Total liabilities...................... $ 90,000Other assets Robin Ingel, capital ............. 105,000

($300,000 + $120,000) ...... 420,000 Michael Jay, capital ............. 135,000Laureen Kahn, capital......... 120,000Total liabilities

Total assets ............................ $450,000 and capital....................... $450,000

Kahn’s one-third interest in the partnership does not necessarily entitle her toone-third of the profits. The sharing of profits and losses is a separate element in thepartnership agreement.

Admission by Investing in the Partnership—Bonus to the Old Partners Themore successful a partnership, the higher the payment the partners may demandfrom a person entering the business. Partners in a business that is doing quite wellmight require an incoming person to pay them a bonus. The bonus comes into thepartnership, increasing the current partners’ capital accounts.

Suppose that Hiro Nagasawa and Lisa Schwende’s partnership has earnedabove-average profits for ten years. The two partners share profits and losses equally.The balance sheet carries these figures:

Cash ....................................... $ 80,000 Total liabilities ..................... $200,000Other assets .......................... 420,000 Hiro Nagasawa, capital...... 140,000

Lisa Schwende, capital ....... 160,000Total liabilities

Total assets............................ $500,000 and capital ...................... $500,000


Ted and Fred are partners withcapital balances of $32,000 and$48,000, respectively. Profits andlosses are shared on the basis ofcapital balances. Ted and Fredadmit Jill to a 20% interest with a$24,000 investment. What is theentry to record Jill’s admission tothe partnership?

A:Cash......................... 24,000

Jill, Capital ............ 20,800Ted, Capital ........... 1,280Fred, Capital .......... 1,920

Jill: $20,800 = ($32,000 + $48,000+ $24,000) � 0.2

Ted: $1,280 = $32,000/$80,000� ($24,000 – $20,800)

Fred: $1,920 = $48,000/$80,000� ($24,000 – $20,800)

WORKING IT OUT

The partners agree to admit Alana Parker to a one-fourth interest with her cashinvestment of $180,000. Parker’s capital balance on the partnership books is $120,000,computed as follows:

Partnership capital before Parker is admitted ($140,000 + $160,000) .. $300,000Parker’s investment in the partnership ................................................... 180,000Partnership capital after Parker is admitted ........................................... $480,000Parker’s capital in the partnership ($480,000 × 1⁄4) .................................. $120,000Bonus to the old partners ($180,000 – $120,000) ..................................... $ 60,000

In effect, Parker had to buy into the partnership at a price ($180,000) above thebook value of her one-fourth interest ($120,000). Parker’s extra investment of $60,000creates a bonus for the existing partners. The entry on the partnership books torecord Parker’s investment is

Mar. 1 Cash ....................................................................... 180,000Alana Parker, Capital..................................... 120,000Hiro Nagasawa, Capital ................................ 30,000Lisa Schwende, Capital ................................. 30,000

To admit A. Parker as a partner with a one-fourthinterest in the business. Nagasawa and Schwendeeach receive a bonus of $30,000 ($60,000 × 1⁄2).

Parker’s capital account is credited for her one-fourth interest in the partnership. Thebonus is allocated to the original partners (Nagasawa and Schwende) based ontheir profit-and-loss ratio.

The new partnership’s balance sheet reports these amounts:

Cash ($80,000 + $180,000) $260,000 Total liabilities ................... $200,000Other assets........................ 420,000 Hiro Nagasawa, capital

($140,000 + $30,000)..... 170,000Lisa Schwende, capital

($160,000 + $30,000)..... 190,000Alana Parker, capital ........ 120,000Total liabilities

Total assets ......................... $680,000 and capital .................... $680,000

Admission by Investing in the Partnership—Bonus to the New Partner Apotential new partner may be so important that the existing partners offerhim or her a partnership share that includes a bonus. A law firm may stronglydesire a former premier, cabinet minister, or other official as a partner becauseof the person’s reputation. A restaurant owner may want to go into partnershipwith a famous sports personality like Wayne Gretzky or a singer like Shania Twain.

Suppose Jenny Page and Miko Osuka have a law partnership. The firm’s balancesheet appears as follows:

Cash .................................... $210,000 Total liabilities .................... $180,000Other assets ....................... 540,000 Jenny Page, capital ............ 345,000

Miko Osuka, capital .......... 225,000Total liabilities

Total assets ......................... $750,000 and capital ..................... $750,000

The partners admit Martin Schiller, a former provincial Finance Minister, as a part-ner with a one-third interest in exchange for his cash investment of $150,000. At thetime of Schiller’s admission, the firm’s capital is $570,000—Page, $345,000 plus Osuka,$225,000. Page and Osuka share profits and losses in the ratio of two-thirds to Page andone-third to Osuka. The computation of Schiller’s equity in the partnership is


Notice in the March 1 journal entrythat Nagasawa’s and Schwende’scapital accounts increasedbecause of Parker’s investment,but that Nagasawa and Schwendehave not received cash. All thecash went into the partnership.Their increased capital accountsinclude the bonus amountcontributed by Parker.

LEARNING TIP

The bonus in this example isshared equally by the existingpartners because they shareprofits and losses equally. A bonusis normally shared by the existingpartners in the profit-sharing ratio.

LEARNING TIP

Mia and Susan are partners withcapital balances of $25,000 and$75,000, respectively. They shareprofits and losses in a 30:70 ratio.Mia and Susan admit Tab to a 10%interest in a new partnership whenTab invests $20,000 in thebusiness.1. Journalize the partnership’s

receipt of cash from Tab.2. What is each partner’s capital in

the new partnership?

A: 1. Cash 20,000

Tab, Capital 12,000Mia, Capital 2,400Susan, Capital 5,600

To admit Tab with a 10% interest inthe business.

Partnership capital before Tab is admitted ($25,000 + $75,000) $100,000Tab’s investment in the partnership 20,000Partnership capital after Tab is admitted $120,000Tab’s capital in the partnership ($120,000 � 1/10) $ 12,000Bonus to the old partners($20,000 – $12,000) $ 8,000Mia’s bonus is $2,400 ($8,000 � 0.30) and Susan’s bonus is $5,600 ($8,000 � 0.70).

2. Partners’ capital balances:Mia, capital ($25,000 + $2,400) $ 27,400Susan, capital ($75,000 + $5,600) $ 80,600Tab, capital $ 12,000Total partnershipcapital $120,000

WORKING IT OUT

Partnership capital before Schiller is admitted($345,000 + $225,000) ............................................................................. $570,000

Schiller’s investment in the partnership ................................................. 150,000Partnership capital after Schiller is admitted ......................................... $720,000Schiller’s capital in the partnership ($720,000 × 1⁄3) ................................ $240,000Bonus to new partner ($240,000 – $150,000) ........................................... $ 90,000

In this case, Schiller bought into the partnership at a price ($150,000) below thebook value of his interest ($240,000). The bonus of $90,000 went to Schiller from the otherpartners. The capital accounts of Page and Osuka are debited for the $90,000 differencebetween the new partner’s equity ($240,000) and his investment ($150,000). The existingpartners share this decrease in capital, which is accounted for as though it were a loss,based on their profit-and-loss ratio. The entry to record Schiller’s investment is

Aug. 24 Cash ..................................................................... 150,000Jenny Page, Capital ($90,000 × 2⁄3) .................... 60,000Miko Osuka, Capital ($90,000 × 1⁄3) .................. 30,000

Martin Schiller, Capital ................................ 240,000To admit M. Schiller as a partner with aone-third interest in the business.

The new partnership’s balance sheet reports these amounts:

Cash Total liabilities ...................... $180,000($210,000 + $150,000) ..... $360,000 Jenny Page, capital

Other assets .......................... 540,000 ($345,000 – $60,000) ........ 285,000Miko Osuka, capital

($225,000 – $30,000) ........ 195,000Martin Schiller, capital ........ 240,000Total liabilities

Total assets............................ $900,000 and capital ....................... $900,000

Withdrawal of a Partner from theBusiness

A partner may withdraw from the business for many reasons, including retirementor a dispute with the other partners. The withdrawal of a partner dissolves the oldpartnership. The partnership agreement should contain a provision to govern how tosettle with a withdrawing partner. In the simplest case, as illustrated on page 674, a part-ner may withdraw and sell his or her interest to another partner in a personal trans-action. The only entry needed to record this transfer of equity debits the withdrawingpartner’s capital account and credits the purchaser’s capital account. The dollar amountof the entry is the capital balance of the withdrawing partner, regardless of the price paidby the purchaser. The accounting when one current partner buys a second partner’s in-terest is the same as when an outside party buys a current partner’s interest.

If the partner withdraws in the middle of the accounting period, the partnershipbooks should be updated to determine the withdrawing partner’s capital balance. Thebusiness must measure net income or net loss for the fraction of the year up to the with-drawal date, and allocate profit or loss according to the existing ratio. An alternative isto set an amount in the partnership agreement to be allocated regardless of the finalannual results. This could be appropriate in businesses that have seasonal fluctations,where the selection of withdrawal date could lead to unfair allocations. After the bookshave been closed, the business then accounts for the change in partnership capital.

The withdrawing partner may receive his or her share of the business in partnershipassets other than cash. The question then arises of what value to assign the partnershipassets—book value or current market value? The settlement procedure may specify anindependent appraisal of the assets to determine their current market value. If market


Jan and Ron are partners withcapital balances of $45,000 and$60,000, respectively. They shareprofits and losses in a 25:75 ratio.Jan and Ron admit Lou to a 20%interest in a new partnership whenLou invests $15,000 in thebusiness.1. Journalize the partnership’s

receipt of cash from Lou.2. What is each partner’s capital in

the new partnership?

A: 1. Cash 15,000

Jan, Capital 2,250Ron, Capital 6,750

Lou, Capital 24,000To admit Lou with a 20% interest inthe business.

Partnership capital before Lou is admitted ($45,000 + $60,000) $105,000

Lou’s investment in the partnership 15,000

Partnership capitalafter Lou is admitted 120,000

Lou’s capital in thepartnership($120,000 � 0.20) $ 24,000

Bonus to the newpartner($24,000 – $15,000) $ 9,000

Jan’s decrease in capital is $2,250($9,000 � 0.25) and Ron’s decrease is$6,750 ($9,000 � 0.75).

2. Partner’s capital balances:

Jan, capital ($45,000 – $2,250) $ 42,750

Ron, capital ($60,000 – $6,750) 53,250

Lou, capital 24,000

Total partnershipcapital $120,000

WORKING IT OUT

OBJECTIVE 5Account for the withdrawal of apartner from the business

When a partner leaves apartnership, she or he ceases to bean agent and no longer has theauthority to bind the business tocontracts. Third parties with whomthe partnership has dealt shouldbe notified that the exiting partnerno longer can bind the partnership.For all other third parties,constructive notice, such as anadvertisement in the newspaper, issufficient.

KEY POINT

values have changed, the appraisal will result in a revaluing of the partnership assets.Thus the partners share in any market value changes that their efforts caused.

Suppose Ben Isaac is retiring in midyear from the partnership of Green, Maslowski,and Isaac. After the books have been adjusted for partial-period income but before theasset appraisal, revaluation, and closing entries, the balance sheet reports the following:

Cash........................................... $ 52,000 Total liabilities......................... $ 93,000Inventory.................................. 44,000 Joan Green, capital ................. 54,000Land .......................................... 55,000 Ivan Maslowski, capital......... 43,000Building.................. $95,000 Ben Isaac, capital .................... 21,000Less: Accumulated

amortization ....... 35,000 60,000 Total liabilities Total assets ............. $211,000 and capital .......................... $211,000

An independent appraiser revalues the inventory at $38,000 (down from $44,000),and the land at $101,000 (up from $55,000). The partners share the differences be-tween these assets’ market values and their prior book values based on their profit-and-loss ratio.

The partnership agreement has allocated one-fourth of the profits to Green, one-half to Maslowski, and one-fourth to Isaac. (This ratio may be written 1:2:1 for onepart to Green, two parts to Maslowski, and one part to Isaac.) For each share thatGreen or Isaac has, Maslowski has two. The entries to record the revaluation of theinventory and land are

June 30 Joan Green, Capital ($6,000 × 1⁄4) ................................ 1,500Ivan Maslowski, Capital ($6,000 × 1⁄2)........................ 3,000Ben Isaac, Capital ($6,000 × 1⁄4) ................................... 1,500

Inventory ($44,000 – $38,000)................................ 6,000To revalue the inventory and allocate the lossin value to the partners.

June 30 Land ($101,000 – $55,000) ......................................... 46,000Joan Green, Capital ($46,000 × 1⁄4) ....................... 11,500Ivan Maslowski, Capital ($46,000 × 1⁄2) .............. 23,000Ben Isaac, Capital ($46,000 × 1⁄4) .......................... 11,500

To revalue the land and allocate the gain invalue to the partners.

After the revaluations, the partnership balance sheet reports:

Cash ....................................... $ 52,000 Total liabilities ......................... $ 93,000Inventory............................... 38,000 Joan Green, capital ($54,000 –Land ....................................... 101,000 $1,500 + $11,500) ................ 64,000Building .................. $95,000 Ivan Maslowski, capital ($43,000 –Less: Accumulated $3,000 + $23,000) ............... 63,000

amortization .. 35,000 60,000 Ben Isaac, capital ($21,000 –$1,500 + $11,500) ................ 31,000

Total liabilities Total assets ............................ $251,000 and capital .......................... $251,000

The books now carry the assets at current market value, which becomes the newbook value, and the capital accounts have been adjusted accordingly. As the bal-ance sheet shows, Isaac has a claim to $31,000 in partnership assets. How is his with-drawal from the business accounted for?

Withdrawal at Book ValueIf Ben Isaac withdraws by taking cash equal to the book value of his owner’s equity,the entry would be


Jane, Karol, and Leah are partnerswith capital account balances of$20,000, $30,000, and $50,000,respectively. They share profits ina 2:3:5 ratio. Karol is withdrawingfrom the business, so the partnershave the assets appraised. Thebuilding’s market value is $4,000more than its book value. Theinventory’s market value is $6,000less than cost. What are thejournal entries to revalue theseassets?

A:Building .............. 4,000

Jane, Capital.... 800Karol, Capital ... 1,200Leah, Capital.... 2,000

Jane, Capital...... 1,200Karol, Capital ..... 1,800Leah, Capital ...... 3,000

Inventory .......... 6,000

WORKING IT OUT

What are the partners’ capitalaccount balances after therevaluations in the previousWorking It Out?

A:Jane: ($20,000 + $800 – $1,200) = $19,600Karol: ($30,000 + $1,200 – $1,800)= $29,400Leah: ($50,000 + $2,000 – $3,000)= $49,000

WORKING IT OUT

June 30 Ben Isaac, Capital................................................... 31,000Cash.................................................................... 31,000

To record withdrawal of B. Isaac from the part-nership.

This entry records the payment of partnership cash to Isaac and the closing of his capital account upon his withdrawal from the business.

Withdrawal at Less Than Book ValueThe withdrawing partner may be so eager to leave the business that she or he iswilling to take less than her or his equity. Assume Ben Isaac withdraws from the busi-ness, and agrees to take partnership cash of $10,000 and the new partnership’s notefor $15,000. This $25,000 settlement is $6,000 less than Isaac’s $31,000 equity in thebusiness. The remaining partners share this $6,000 difference—which is a bonus tothem—according to their profit-and-loss ratio.

Because Isaac has withdrawn from the partnership, a new agreement—and anew profit-and-loss ratio—must be drawn up. Maslowski and Green, in forminga new partnership, may decide on any ratio that they see fit. Let’s assume theyagree that Maslowski will earn two-thirds of partnership profits and losses, andGreen one-third. The entry to record Isaac’s withdrawal at less than book value is

June 30 Ben Isaac, Capital ................................................. 31,000Cash .................................................................. 10,000Note Payable to Ben Isaac.............................. 15,000Joan Green, Capital ........................................ 2,000Ivan Maslowski, Capital ............................... 4,000

To record withdrawal of B. Isaac from the part-nership. Green’s bonus is $2,000 ($6,000 � 1⁄3)and Maslowski’s bonus is $4,000 ($6,000 � 2⁄3)

Isaac’s account is closed, and Maslowski and Green may or may not continue thebusiness as a new partnership.

Withdrawal at More Than Book ValueThe settlement with a withdrawing partner may allow him or her to take assets ofgreater value than the book value of that partner’s capital. Also, the remaining part-ners may be so eager for the withdrawing partner to leave the firm that they pay thepartner a bonus to withdraw from the business. In either case, the partner’s with-drawal causes a decrease in the book equity of the remaining partners. This de-crease is allocated to the partners based on their profit-and-loss ratio.

The accounting for this situation follows the pattern illustrated for withdrawal at lessthan book value—with one exception. The remaining partners’ capital accounts aredebited because the withdrawing partner receives more than his or her book equity.

Suppose Linda is withdrawing from the partnership of Linda, Jacob, and Karla. Thepartners share profits and losses in a 1:2:3 ratio for Linda, Jacob, and Karla, respectively.After the revaluation of assets, Linda’s capital balance is $100,000, and the other part-ners agree to pay her $120,000. The journal entry to record the payment to Lindaand her withdrawal from the partnership is

Linda, Capital................................................... 100,000Jacob, Capital.................................................... 8,000Karla, Capital.................................................... 12,000

Cash ........................................................ 120,000To record withdrawal of Linda from the business. Jacob’s capital is reduced by $8,000 [($120,000 – $100,000) � 2⁄5] and Karla’s capital is reduced by $12,000 [(120,000 – $100,000) � 3⁄5].


Refer to the Working It Outs onpage 678. Assume that Karol iswilling to accept $20,000 for hispartnership interest. What is thejournal entry to record hiswithdrawal from the business?

A:Karol, Capital ....... 29,400

Cash ................... 20,000Jane, Capital...... 2,686*Leah, Capital...... 6,714†

*$9,400 � 2/7 = 2,686†$9,400 � 5/7 = $6,714Jane and Leah will now share profits in a2:5 ratio.

WORKING IT OUT

Refer to the Working It Outs onpage 678. Assume that Jane andLeah agree to pay Karol $40,000for his partnership interest. Whatis the journal entry to record hiswithdrawal from the business?

A:Jane, Capital...... 3,029*Karol, Capital ..... 29,400Leah, Capital ...... 7,571†

Cash ................. 40,000

*$10,600 � 2/7 = $3,029†$10,600 � 5/7 = $7,571

WORKING IT OUT

Death of a PartnerLike any other form of partnership withdrawal, the death of a partner dissolves apartnership. The partnership accounts are adjusted to measure net income or lossfor the fraction of the year up to the date of death, then closed to determine thepartners’ capital balances on that date. Settlement with the deceased partner’s es-tate is based on the partnership agreement. The estate commonly receives part-nership assets equal to the partner’s capital balance. The partnership closes thedeceased partner’s capital account with a debit. This entry credits a payable to theestate.

Suppose Joan Green (of the partnership on page 678) dies after all accounts havebeen adjusted to current market value. Green’s capital balance is $64,000. Green’s es-tate may request cash for her final share of the partnership’s assets. At this timethe business has only $52,000 of cash, so it must borrow. Let’s assume the partner-ship borrows $50,000 and then pays Green’s estate for her capital balance. The part-nership’s journal entries are

July 1 Cash ........................................................ 50,000Note payable .................................... 50,000

To borrow money

July 1 Joan Green, Capital............................... 64,000Cash................................................... 64,000

To record withdrawal of Green from the business.

Alternatively, a remaining partner may purchase the deceased partner’s equity. Thedeceased partner’s equity is debited and the purchaser’s equity is credited. Theamount of this entry is the ending credit balance in the deceased partner’s capitalaccount.

Liquidation of a PartnershipAdmission of a new partner or withdrawal or death of an existing partner dissolvesthe partnership. However, the business may continue operating with no apparentchange to outsiders such as customers and creditors. In contrast, business liquida-tion is the process of going out of business by selling the entity’s assets and paying itsliabilities. The final step in liquidation of a business is the distribution of the remainingcash to the owners. Before the business is liquidated, the books should be adjusted andclosed. After closing, only asset, liability, and partners’ capital accounts remain open.

Liquidation of a partnership includes three basic steps:

1. Sell the assets. Allocate the gain or loss to the partners’ capital accounts basedon the profit-and-loss ratio.

2. Pay the partnership liabilities.3. Disburse the remaining cash to the partners in proportion to their capital bal-

ances.

In actual practice, the liquidation of a business can stretch over weeks or months.Selling every asset and paying every liability of the entity takes time. For example,the liquidation of a law firm of over 75 partners took almost a year.

To avoid excessive detail in our illustrations, we include only two asset cate-gories—Cash and Noncash Assets—and a single liability category—Liabilities. Ourexamples also assume that the business sells the noncash assets in a single transactionand pays the liabilities in a single transaction. (In actual practice, each asset and itsrelated amortization would be accounted for separately when it is sold, and each li-ability would be accounted for separately when it is paid.)

Assume that Jane Aviron, Elaine Bloch, and Kim Zhang have shared profits and


REAL WORLD EXAMPLE

Partners commonly carry lifeinsurance on themselves, with thepartners as beneficiaries. In theevent of a death, the partnersreceive the cash flow necessary tosettle with the deceased partner’sestate, without putting thepartnership into financial jeopardy.

OBJECTIVE 6Account for the liquidation of apartnership

Remember that the profit-and-lossratio is used to divide gains andlosses. The partners’ capitalbalances are used to divide assets.

When a business liquidatesthere may not be enough cash topay the liabilities. The partners(who are personally liable for thepartnership debts) must contributecash on the basis of their profit-and-loss ratio to cover unpaiddebts.

KEY POINT

Partners’ profit-and-loss ratio neednot match the partners’ capitalbalances. Here, for example, JaneAviron has a 60% sharing ratio butowns 4⁄7 (or 57%) of the capital.

WORKING IT OUT

losses in the ratio of 3:1:1. (This ratio is equal to 3⁄5, 1⁄5, 1⁄5, or a 60-percent, 20-percent,20-percent sharing ratio.) They decide to liquidate their partnership. After the booksare adjusted and closed, the general ledger contains the following balances:

Cash .................................... $ 20,000 Liabilities ........................... $ 60,000Noncash assets .................. 180,000 Jane Aviron, capital .......... 80,000

Elaine Bloch, capital ......... 40,000Kim Zhang, capital........... 20,000Total liabilities

Total assets ......................... $200,000 and capital .................... $200,000

Sale of Noncash Assets at a GainAssume the Aviron, Bloch, and Zhang partnership sells its noncash assets (shown onthe balance sheet at $180,000) for cash of $300,000. The partnership realizes a gain of$120,000, which is allocated to the partners based on their profit-and-loss-sharingratio. The entry to record this sale and allocation of the gain is

Oct. 31 Cash...................................................................... 300,000Noncash Assets.............................................. 180,000Jane Aviron, Capital ..................................... 72,000Elaine Bloch, Capital .................................... 24,000Kim Zhang, Capital ..................................... 24,000

To sell noncash assets in liquidation and allocate gain to partners. Aviron’s share of the gain is $72,000 ($120,000 � 0.60), Bloch’s and Zhang’s is $24,000 ($120,000 � 0.20).

The partnership must next pay off its liabilities:

Oct. 31 Liabilities ............................................................... 60,000Cash .................................................................. 60,000

To pay liabilities in liquidation.

In the final liquidation transaction, the remaining cash is disbursed to the part-ners. The partners share in the cash according to their capital balances. (By contrast, gainsand losses on the sale of assets are shared by the partners based on theirprofit-and-loss-sharing ratio.) The amount of cash left in the partnership is $260,000—the $20,000 beginning balance plus the $300,000 cash sale of assets minus the $60,000cash payment of liabilities. The partners divide the remaining cash according totheir capital balances:

Oct. 31 Jane Aviron, Capital ($80,000 + $72,000) .......... 152,000Elaine Bloch, Capital ($40,000 + $24,000) ......... 64,000Kim Zhang, Capital ($20,000 + $24,000)........... 44,000

Cash.................................................................. 260,000To disburse cash to partners in liquidation.

A convenient way to summarize the transactions in a partnership liquidation isgiven in Exhibit 12-4.

After the disbursement of cash to the partners, the business has no assets, liabilities,or owners’ equity. All the balances are zero. By the accounting equation, partnershipassets must equal partnership liabilities plus partnership capital.

Sale of Noncash Assets at a LossLiquidation of a business often includes the sale of noncash assets at a loss. Whenthis occurs, the partners’ capital accounts are debited as they share the loss in theirprofit-and-loss-sharing ratio. Otherwise, the accounting follows the pattern illustratedfor the sale of noncash assets at a gain.


Kelly and Keith are partners in apartnership with cash of $10,000and noncash assets of $50,000.The capital balances of Kelly andKeith are $40,000 and $20,000,respectively. The partners shareprofits and losses 60:40. Thenoncash assets are sold for$56,000. All liabilities have beenpaid. What journal entries recordsale of the assets and distributionof cash to the partners?

A:Cash......................... 56,000

Noncash Assets .... 50,000Kelly, Capital ......... 3,600*Keith, Capital......... 2,400†

*$6,000 gain � 60% = $3,600†$6,000 � 40% = $2,400

Kelly, Capital($40,000 + $3,600) .... 43,600

Keith, Capital($20,000 + $2,400) .... 22,400

Cash ..................... 66,000

WORKING IT OUT

REAL WORLD EXAMPLE

In the US in 1991, Laventhol andHorwath, then the seventh-largestaccounting partnerhip, declaredbankruptcy. The 250 partners werepersonally liable for US $47.3million in partnership obligationsthat resulted from actions of onlyia few partners.

Keep in mind that, uponliquidation, gains on the sale ofassets are divided according to theprofit-and-loss ratio. The final cashdisbursement is based on capitalbalances.

LEARNING TIP


Capital

Aviron Bloch ZhangCash + Noncash Assets = Liabilities + (60%) + (20%) + (20%)

Balances before sale ofassets .............................. $ 20,000) $180,000) $ 60,000) $ 80,000) $40,000) $ 20,000)

Sale of assets andsharing of gain.............. 300,000) (180,000) 72,000) 24,000) 24,000)

Balances .............................. 320,000) -0- ) 60,000) 152,000) 64,000) 44,000)Payment of liabilities ........ (60,000) (60,000)Balances .............................. 260,000) -0- ) -0- ) ) )Disbursement of cash

to partners ..................... (260,000) (152,000) (64,000) (44,000)Balances .............................. $ -0- ) $ -0- ) $ -0- ) $ -0- ) $ -0- ) $ -0- )

Panel A—Partnership Panel B—Proprietorship

GRAY AND HUI CONSULTINGIncome statement

For the Year Ended December 31, 2003

Revenues ...................................... $460Expenses....................................... (270)Net income................................... $190Allocation of net income:

To Leslie Gray......................... $114To Andrew Hui....................... 76 $190

GRAY AND HUI CONSULTINGStatement of Owners’ Equity


Gray Hui

Capital, January 1, 2003 ............. $50 $40Additional investments ............. 10 —Net income................................... 114 76

Subtotal .................................... 174 116Withdrawals ................................ (72) (48)Capital, December 31, 2003 ....... $102 $68

GRAY AND HUI CONSULTINGBalance Sheet

December 31, 2003

AssetsCash and other assets ..................................... $170

Partners’ EquityLeslie Gray, capital ........................................ $102Andrew Hui, capital ...................................... 68Total capital...................................................... $170

GRAY CONSULTINGIncome statement


Revenues .......................................................... $460Expenses........................................................... (270)Net income....................................................... $190

GRAY CONSULTINGStatement of Owner’s Equity


Capital, January 1, 2003.................................. $90Additional investments.................................. 10Net income....................................................... 190

Subtotal......................................................... 290Withdrawals .................................................... (120)Capital, December 31, 2003 ........................... $170

GRAY CONSULTINGBalance Sheet

December 31, 2003

AssetsCash and other assets ..................................... $170

Owner’s EquityLeslie Gray, capital.......................................... $170

EXHIBIT 12-4

Partnership Liquidation—Sale of Assets at a Gain

EXHIBIT 12-5

Financial Statements of a Partnership and a Proprietorship

Partnership Financial StatementsPartnership financial statements are much like those of a proprietorship. However,a partnership income statement includes a section showing the division of net incometo the partners. For example, the partnership of Leslie Gray and Andrew Hui mightreport its income statement for the year ended December 31, 2003, as shown inPanel A of Exhibit 12-5 on page 682. A proprietorship’s financial statements arepresented for comparison.

Large partnerships may not find it feasible to report the net income of everypartner. Instead, the firm may report the allocation of net income to active andretired partners and average earnings per partner. For example, Exhibit 12-6 showshow the accounting and consulting firm of Main, Price & Anders reported itsearnings.

The Decision Guidelines feature on pages 684–685 summarizes the main pointsof accounting for partnerships.


MAIN, PRICE & ANDERSCombined Statement of Earnings

For the Year Ended August 31, 2002

Fees for Professional Services................................................................ $9,144,920

Earnings for the year .............................................................................. $2,978,800Allocation of earnings

To partners active during the year—Resigned, retired, and deceased partners ................................. $ 199,010Partners active at year end .......................................................... 2,620,291

To retired and deceased partners—Retirement and death benefits .................................................... 83,100

Not allocated to partners—retained for specific partnership purposes ......................................................................................... 76,399

$2,978,800

Average earnings per partner at year end (28 partners) ................... $ 106,400

EXHIBIT 12-6

Reporting Net Income for aLarge Partnership

OBJECTIVE 7Prepare partnership financialstatements


STOP & THINK

Suppose the Aviron, Bloch, and Zhang partnership sold its noncash assets for $60,000 andall other details in Exhibit 12-4 remained the same. This creates a loss of $120,000 on the saleof the noncash assets. Allocate the loss to the partners. Identify ways that the partnershipcould deal with the negative balance (a capital deficiency) in Zhang’s capital account.

Answer: Allocation of the $120,000 loss on the sale of assets is shown below.

Decision Guidelines

Accounting for Partnerships

How to organize the business?

On what matters should the partners agree?

At what value does the partnership recordassets and liabilities?

How are partnership profits and losses sharedamong the partners?

A partnership offers both advantages and disadvantages in comparison withproprietorships and corporations. (See Exhibit 12–2, page 665.)

See the list on page 663, under the heading “The Written Partnership Agreement.”

Current market value on the date of acquisition, because, in effect, the partnership isbuying its assets at their current market value.

• Equally if there is no profit-and-loss sharing agreement.• As provided in the partnership agreement. Can be based on the partners’

a. Stated fractionsb. Capital contributionsc. Service to the partnershipd. “Salaries” and interest on their capital contributions.

Capital

Aviron Bloch ZhangCash + Noncash Assets = Liabilities + (60%) + (20%) + (20%)

$ 20,000 $180,000 $ 60,000 $ 80,000 $ 40,000 $ 20,000

60,000 (180,000) (72,000) (24,000) (24,000)

80,000 -0- 60,000 8,000 16,000 (4,000)(60,000) (60,000)

20,000 -0- -0- 8,000 16,000 (4,000)

(20,000) (8,000) (16,000) 4,000)

$ -0- $ -0- $ -0- $ -0- $ -0- $ -0-

To deal with the $4,000 capital deficiency in Zhang’s Capital account, two possibilities are:1. Zhang could contribute assets to the partnership in an amount equal to her capital defi-

ciency. If Zhang contributed cash, the journal entry to record this is

Cash ................................................................. 4,000Kim Zhang, Capital ................................... 4,000

2. Kim Zhang’s partners, Jane Aviron and Elaine Bloch, could agree to absorb Zhang’scapital deficiency by decreasing their own capital balances in proportion to their re-maining profit-sharing percentages: Aviron, 60/80; Bloch, 20/80. The journal entry torecord this is

Jane Aviron, Capital....................................... 3,000Elaine Bloch, Capital ..................................... 1,000

Kim Zhang, Capital ................................... 4,000

Balances beforesale of assets ....................

Sale of assetsand sharing of loss .........

Balances.................................Payment of liabilities...........

Balances.................................Disbursement of cash

to partners .......................

Balances.................................


What happens when a partner withdraws fromthe partnership?

How are new partners admitted to thepartnership?

How to account for the withdrawal of a partnerfrom the business?

What happens if the partnership goes out ofbusiness?

How do partnership financial statements differfrom those of a proprietorship?

The old partnership ceases to exist. The remaining partners may or may not form a newpartnership.

• Purchase a partner’s interest. The old partnership is dissolved. The remainingpartners may admit the new partner to the partnership. If not, the new partner getsno voice in the management of the firm but shares in the profits and losses of thepartnership. Close the withdrawing partner’s Capital account, and open a Capitalaccount for the new partner. Carry over the old partner’s Capital balance to theCapital account of the new partner.

• Invest in the partnership. Buying in at book value creates no bonus to any partner.Buying in at a price above book value creates a bonus to the old partners. Buying inat a price below book value creates a bonus for the new partner.

• First, adjust and close the books up to the date of the partner’s withdrawal from thebusiness.

• Second, appraise the assets and the liabilities to determine their current marketvalue.

• Third, account for the partner’s withdrawala. At book value (no change in remaining partners’ Capital balances)b. At less than book value (increase the remaining partners’ Capital

balances)c. At more than book value (decrease the remaining partners’ Capital

balances)

Liquidate the partnership, as follows:a. Adjust and close the partnership books up to the date of liquidation.b. Sell the partnership’s assets. Allocate gain or loss to the partners’

Capital accounts based on their profit-and-loss ratio.c. Pay the partnership liabilities.d. Pay any remaining cash to the partners based on their Capital balances.

• The partnership income statement reports the allocation of net income or net loss tothe partners.

• The partnership balance sheet (or a separate schedule) reports the Capital balanceof each partner.

• The cash flow statement is the same for a partnership as for a proprietorship.

Summary ProblemSummary Problemfor Your Review

The partnership of Taylor and Uvalde is considering admitting Steven Vaughn as apartner on January 2, 2002. The partnership general ledger includes the followingbalances on that date:

Cash .................................... $ 18,000 Total liabilities.................... $100,000Other assets........................ 220,000 Debby Taylor, capital ........ 90,000

Thomas Uvalde, capital.... 48,000Total liabilities

Total assets.......................... $238,000 and capital..................... $238,000

Debby Taylor’s share of profits and losses is 60 percent and Thomas Uvalde’sshare is 40 percent.

Required

(Items 1 and 2 are independent.)

1. Suppose Vaughn pays Uvalde $62,000 to acquire Uvalde’s interest in the businessafter Taylor approves Vaughn as a partner.a. Record the transfer of owner’s equity on the partnership books.b. Prepare the partnership balance sheet immediately after Vaughn is admitted

as a partner.2. Suppose that Vaughn becomes a partner by investing $62,000 cash to acquire a

one-fourth interest in the business.a. Compute Vaughn’s capital balance and record his investment in the business.b. Prepare the partnership balance sheet immediately after Vaughn is admitted

as a partner. Include the appropriate heading.3. Which way of admitting Vaughn to the partnership increases its total assets?

Give your reason.

Solution to Review ProblemRequirement 1

a. 2002Jan. 2 Thomas Uvalde, Capital.............................. 48,000

Steven Vaughn, Capital ........................... 48,000To transfer Uvalde’s equity in the partnership to Vaughn.

b. The balance sheet for the partnership of Taylor and Vaughn is identical to thebalance sheet given for Taylor and Thomas Uvalde in the problem, except StevenVaughn’s name replaces Thomas Uvalde’s name in the title and in the listing ofCapital accounts.

Requirement 2

a. Computation of Vaughn’s capital balance:

Partnership capital before Vaughn is admitted($90,000 + $48,000) ................................................................... $138,000

Vaughn’s investment in the partnership ..................................... 62,000Partnership capital after Vaughn is admitted ............................. $200,000Vaughn’s capital in the partnership ($200,000 × 1⁄4) .................... $ 50,000

2002Jan. 2 Cash .............................................................. 62,000

Steven Vaughn, Capital.......................... 50,000Debby Taylor, Capital............................. 7,200Thomas Uvalde, Capital ........................ 4,800

To admit Vaughn as a partner with aone-fourth interest in the business. Taylor’sbonus is $7,200 [($62,000 – $50,000) × 0.60]and Uvalde’s bonus is $4,800 [($62,000 – $50,000) × 0.40].



b.TAYLOR, UVALDE, AND VAUGHN

Balance SheetJanuary 2, 2002

Cash* $ 80,000 Total liabilities ........................ $100,000Other assets ............................ 220,000 Debby Taylor, capital**.......... 97,200

Thomas Uvalde, capital*** ... 52,800Steven Vaughn, capital.......... 50,000

Total liabilities Total assets......................... $300,000 and capital ......................... $300,000

*$18,000 + $62,000 = $80,000**$90,000 + $ 7,200 = $97,200

*** $48,000 + $ 4,800 = $52,800

Requirement 3

Vaughn’s investment in the partnership increases its total assets by the amount ofhis contribution. Total assets of the business are $300,000 after his investment, com-pared to $238,000 before. By contrast, Vaughn’s purchase of Uvalde’s interest inthe business is a personal transaction between the two individuals. It does not affectthe assets of the partnership regardless of the amount Vaughn pays Uvalde.

Summary1. Identify the characteristics of a partnership. A partner-

ship is a business co-owned by two or more persons forprofit. The characteristics of this form of business organi-zation are its ease of formation, limited life, mutual agency,unlimited liability, and no partnership income taxes. In a limitedpartnership, the limited partners have limited personal lia-bility for the obligations of the business.

A written partnership agreement establishes proceduresfor admission of a new partner, withdrawals of a partner,and the sharing of profits and losses among the partners.When a new partner is admitted to the firm or an exist-ing partner withdraws, the old partnership is dissolved, orceases to exist. A new partnership may or may not emergeto continue the business.

2. Account for partners’ initial investments in a partner-

ship. Accounting for a partnership is similar to accountingfor a proprietorship. However, a partnership has morethan one owner. Each partner has an individual capitalaccount and a withdrawal account.

3. Allocate profits and losses to the partners by differ-

ent methods. Partners share net income or loss in anymanner they choose. Common sharing agreements basethe profit-and-loss ratio on a stated fraction, partners’ cap-ital contributions, and/or their service to the partnership.Some partnerships call the cash withdrawals of partnerssalaries and interest, but these amounts are not expensesof the business. Instead, they are merely ways to describethe allocation of partnership net income to the partners.

4. Account for the admission of a new partner to the

business. An outside person may become a partner bypurchasing a current partner’s interest or by investing inthe partnership. In some cases the new partner must paythe current partners a bonus to join. In other situations thenew partner may receive a bonus to join.

5. Account for the withdrawal of a partner from the busi-

ness. When a partner withdraws, partnership assets maybe reappraised. Partners share any gain or loss on the assetrevaluation on the basis of their profit-and-loss ratio. Thewithdrawing partner may receive payment equal to,

Visit the Student Resources area of the Accounting CompanionWebsite for extra practice with the new material in Chapter 12.

www.pearsoned.ca/horngren

CyberCoach

greater than, or less than her or his capital book value, de-pending on the agreement with the other partners.

6. Account for the liquidation of a partnership. In liqui-dation, a partnership goes out of business by selling theassets, paying the liabilities, and disbursing any remainingcash to the partners.

7. Prepare partnership financial statements. Partnership fi-nancial statements are similar to those of a proprietorship.However, the partnership income statement commonlyreports the allocation of net income to the partners, andthe balance sheet has a Capital account for each partner.


Self-Study QuestionsTest your understanding of the chapter by marking thecorrect answer for each of the following questions:1. Which of these characteristics does not apply to a

partnership? (p. 664)a. Unlimited life c. Unlimited liabilityb. Mutual agency d. No income tax paid by

the business entity2. A partnership records a partner’s investment of as-

sets in the business at (p. 666)a. The partner’s book value of the assets investedb. The market value of the assets investedc. A special value set by the partnersd. Any of the above, depending upon the partner-

ship agreement3. The partnership of Lane, Murdock, and Nu divides

profits in the ratio of 4:5:3. During 2003, the busi-ness earned $40,000. Nu’s share of this income is(p. 669)a. $10,000 c. $16,000b. $13,333 d. $16,667

4. Suppose the partnership of Lane, Murdock, andNu in the preceding question lost $40,000 during2003. Murdock’s share of this loss is (p. 670)a. Not determinable because the ratio applies only

to profitsb. $13,333c. $16,000d. $16,667

5. The partners of Placido, Quinn, and Rolfe shareprofits and losses 1⁄5, 1⁄6, and 19⁄30. During 2004,the first year of their partnership, the businessearned $120,000, and each partner withdrew$50,000 for personal use. What is the balance inRolfe’s capital account after all closing entries? (pp. 673–674)a. Not determinable because Rolfe’s beginning cap-

ital balance is not givenb. Minus $10,000c. $26,000d. $70,000

6. Barbara Fuller buys into the partnership of Graffand Harrell by purchasing a one-third interest for$55,000. Prior to Fuller’s entry, Edward Graff’s cap-ital balance was $46,000, and Louisa Harrell’s bal-ance was $52,000; profits and losses were shared

equally. The entry to record Fuller’s buying intothe business is (pp. 675–676)a. Cash ................................................. 55,000

Barbara Fuller, Capital ............. 55,000b. Edward Graff, Capital ................... 27,500

Louisa Harrell, Capital.................. 27,500Barbara Fuller, Capital ............. 55,000

c. Cash ................................................. 55,000Barbara Fuller, Capital ............. 51,000Edward Graff, Capital.............. 2,000Louisa Harrell, Capital ............ 2,000

d. Cash ................................................. 51,000Edward Graff, Capital ................... 2,000Louisa Harrell, Capital.................. 2,000

Barbara Fuller, Capital ............. 55,000

7. The partners of Tsui, Valik, and Wollenberg shareprofits and losses equally. Their capital balancesare $40,000, $50,000, and $60,000 respectively, whenBrenda Wollenberg sells her interest in the part-nership to Brent Valik for $90,000. Raymond Tsuiand Valik continue the business. Immediately afterWollenberg’s retirement, the total assets of the part-nership are (pp. 674–675)a. Increased by $30,000b. Increased by $90,000c. Decreased by $60,000d. The same as before Wollenberg sold her inter-

est to Valik8. Prior to Bill Hogg’s withdrawal from the partner-

ship of Hogg, Ho, and Lee, the partners’ capitalbalances were $140,000, $110,000 and $250,000 respectively. The partners share profits and losses1⁄3, 1⁄4, and 5⁄12. The appraisal indicates that as-sets should be written down by $36,000. ArthurHo’s share of the write-down is (p. 679)a. $7,920 c. $12,000b. $9,000 d. $18,000

9. The process of closing the business, selling the as-sets, paying the liabilities, and disbursing remain-ing cash to the owners is called (pp. 680–681)a. Dissolution c. Withdrawalb. Forming a new d. Liquidation

partnership10. Eric Hirst and Brenda Mallouk have shared profits

and losses equally. Immediately prior to the finalcash disbursement in a liquidation of their part-nership, the books show:

Cash=

Liabilities+

Eric Hirst, Capital+

Brenda Mallouk, Capital

$100,000 $-0- $60,000 $40,000


How much cash should Hirst receive? (p. 681)a. $40,000 c. $60,000b. $50,000 d. None of the above

Answers to the Self-Study Questions follow the SimilarAccounting Terms.

Accounting VocabularyDissolution (p. 664) Mutual agency (p. 664)General partnership (p. 665) Partnership (p. 662)Limited partnership (p. 666) Partnership agreement (p. 663)Limited liability partnership (p. 666) Unlimited personal liability (p. 664)Liquidation (p. 680)

Similar Accounting TermsLimited Liability Partnership LLPLiquidation Winding up the businessOwner’s equity CapitalWithdrawals Drawings

Answers to Self-Study Questions1. a 7. d2. b 8. b ($36,000 × 1⁄4 = $9,000)3. a ($40,000 × 3⁄12 = $10,000) 9. d4. d ($40,000 × 5⁄12 = $16,667) 10. c5. a6. c [($46,000 + $52,000 + $55,000) × 1⁄3 = $51,000; $55,000 – $51,000 = $4,000; $4,000 ÷ 2 = $2,000 each to

Graff and Harrell]

Assignment MaterialQuestions1. List eight items that the partnership agreement

should specify.2. Ron Montgomery, who is a partner in M&N

Associates, commits the firm to a contract for a jobwithin the scope of its regular business operations.What term describes Montgomery’s ability to ob-ligate the partnership?

3. If a partnership cannot pay a debt, who must makepayment? What term describes this obligation ofthe partners?

4. How is income of a partnership taxed?5. Identify the advantages and disadvantages of the

partnership form of business organization.6. Robin Randall and Sylvia Smith’s partnership agree-

ment states that Randall gets 60 percent of profitsand Smith gets 40 percent. If the agreement doesnot discuss the treatment of losses, how are lossesshared? How do the partners share profits and

losses if the agreement specifies no profit-and-loss-sharing ratio?

7. What determines the amount of the credit to a part-ner’s Capital account when the partner contributesassets other than cash to the business?

8. Do partner withdrawals of cash for personal useaffect the sharing of profits and losses by the part-ner? If so, explain how. If not, explain why not.

9. Name two events that can cause the dissolution ofa partnership.

10. Briefly describe how to account for the purchase ofan existing partner’s interest in the business.

11. Jeff Malcolm purchases Sheila Wilson’s interest inthe Wilson & Kareem partnership. What right doesMalcolm obtain from the purchase? What is re-quired for Malcolm to become Paula Kareem’s part-ner?

12. Sal Assissi and Barb Carter each have capital of$75,000 in their business. They share profits in the

ratio of 55:45. Kathy Denman acquires a one-fifthshare in the partnership by investing cash of$50,000. What are the capital balances of the threepartners immediately after Denman is admitted?

13. When a partner resigns from the partnership andreceives assets greater than her or his capital bal-ance, how is the difference shared by the other part-ners?

14. Distinguish between dissolution and liquidationof a partnership.

15. Name the three steps in liquidating a partnership.16. The partnership of Ralls and Sauls is in the process

of liquidation. How do the partners share (a) gainsand losses on the sale of noncash assets, and (b)the final cash disbursement?

17. Compare and contrast the financial statements of aproprietorship and a partnership.

18. Summarize the situations in which partnership al-locations are based on (a) the profit-and-loss ratio,and (b) the partners’ capital balances.


ExercisesExercise 12-1 Partnership characteristics (Obj. 1)

Sandy Saxe and Ida Weiss are forming a business to imprint T-shirts. Saxe suggeststhat they organize as a partnership in order to avoid the unlimited liability of aproprietorship. According to Saxe, partnerships are not very risky.

Saxe explains to Weiss that if the business does not succeed, each partner canwithdraw from the business, taking the same assets that she or he invested at its be-ginning. Saxe states that the main disadvantage of the partnership form of organi-zation is double taxation: First, the partnership pays a business income tax; second, eachpartner also pays personal income tax on her or his share of the business’s profits.

Correct the errors in Saxe’s explanation.

Exercise 12-2 Organizing a business as a partnership (Obj. 1)

Rhonda Hough, a friend from college, approaches you about forming a partner-ship to export software. Since graduation, Rhonda has worked for the World Bank,developing important contacts among government officials and business leadersin Poland and Hungary. Eager to upgrade their data-processing capabilities, EasternEuropeans are looking for ways to obtain computers. Rhonda believes she is in aunique position to capitalize on this opportunity. With your expertise in finance,you would have responsibility for accounting and finance in the partnership.

Required

Discuss the advantages and disadvantages of organizing the export business as apartnership rather than a proprietorship. Comment on the way partnership incomeis taxed.

Exercise 12-3 A partner’s investment in a partnership (Obj. 2)

Val Dierks invests a building in a partnership with Lena Marx. Dierks purchased thebuilding for $600,000. Accumulated amortization on the date of forming the part-nership is $160,000. A real estate appraiser states that the building is now worth$800,000. Dierks wants $800,000 capital in the new partnership, but Marx objects.Marx believes that Dierk’s capital contribution into the partnership should be mea-sured by the book value of her building.

Marx and Dierks seek your advice. Which value of the building is appropriate formeasuring Dierks’s capital—book value or current market value? State the reasonfor your answer. Give the partnership’s journal entry to record Dierks’s investmentin the business.

Exercise 12-4 Investments by partners (Obj. 2)

Duane Warner and Eli Broad are forming the partnership Sunshine Development to

develop a theme park near Victoria. Warner contributes cash of $1 million and landvalued at $15 million. When Warner purchased the land, its cost was $4 million.The partnership will assume Warner’s $1.5 million note payable on the land. Broadinvests cash of $5 million and construction equipment that he purchased for $3.5 mil-lion (accumulated amortization to date, $1.5 million). The equipment’s market valueis equal to its book value.

Required

1. Before recording any journal entries, compute the partnership’s total assets, totalliabilities, and total owners’ equity immediately after organizing.

2. Journalize the partnership’s receipt of assets and liabilities from Warner andfrom Broad. Record each asset at its current market value with no entry to ac-cumulated amortization.

3. Use your journal entries to prove the correctness of total owners’ equity fromrequirement 1.

Exercise 12-5 Recording a partner’s investment (Obj. 2)

Ann Richards has operated an apartment-locater service as a proprietorship. She andTara Holmes have decided to reorganize the business as a partnership, effectiveApril 1. Richards’ investment in the partnership consists of cash, $20,000; accountsreceivable, $11,000 less allowance for uncollectibles, $1,000; office furniture, $3,000less accumulated amortization, $1,000; a small building, $55,000 less accumulatedamortization, $27,500; accounts payable, $4,000; and a note payable to the bank,$10,000.

To determine Richards’ equity in the partnership, she and Holmes hire an inde-pendent appraiser. This outside party provides the following market values of the assets and liabilities that Richards is contributing to the business: cash, accountsreceivable, office furniture, accounts payable, and note payable—the same asRichards’ book value; allowance for uncollectible accounts, $3,000; building, $71,000;and accrued expenses payable (including interest on the note payable), $1,000.

Required

Make the entry on the partnership books to record Richards’ investment.

Exercise 12-6 Computing partners’ shares of net income and net loss (Obj. 3)

Matt Baines and Dave Bristow form a partnership, investing $80,000 and $140,000respectively. Determine their shares of net income or net loss for each of the follow-ing situations:

a. Net loss is $104,000, and the partners have no written partnership agreement.b. Net income is $88,000 and the partnership agreement states that the partners

share profits and losses based on their capital contributions.c. Net loss is $154,000, and the partnership agreement states that the partners share

profits based on their capital contributions.d. Net income is $220,000. The first $120,000 is shared based on the partner capital

contributions. The next $90,000 is based on partner service, with Baines receiving30 percent and Bristow receiving 70 percent. The remainder is shared equally.

Exercise 12-7 Computing partners’ capital balances (Obj. 3)

Matt Baines withdrew cash of $124,000 for personal use, and Dave Bristow withdrewcash of $100,000 during the year. Using the data from situation (d) in Exercise 12-6,journalize the entries to close to each capital account the (a) income summary ac-count, and (b) the partners’ withdrawal accounts. Explanations are not required.Indicate the amount of increase or decrease in each partner’s capital balance. Whatwas the overall effect on partnership capital?


Exercise 12-8 Admitting a new partner (Obj. 4)

Gemma Mendez is admitted to a partnership. Prior to the admission of Mendez, thepartnership books show Susan Hecker’s capital balance at $150,000 and LouisVitale’s capital balance at $75,000. Hecker and Vitale share profits and losses equally.Compute the amount of each partner’s equity on the books of the new partnershipunder each of the following plans:

a. Mendez purchases Vitale’s interest in the business, paying $90,000. The $90,000payment is not invested in the partnership but instead goes directly to Vitale.

b. Mendez invests $75,000 to acquire a one-fourth interest in the partnership.c. Mendez invests $135,000 to acquire a one-fourth interest in the partnership.

Exercise 12-9 Recording the admission of a new partner (Obj. 4)

Make the partnership journal entry to record the admission of Mendez under plansa, b, and c in Exercise 12-8. Explanations are not required.

Exercise 12-10 Withdrawal of a partner from a business (Obj. 5)

After closing the books, Artemis & Chan’s partnership balance sheet reports owner’sequity of $36,000 for Artemis and $48,000 for Chan. Artemis is withdrawing from thefirm. He and Chan agree to write down partnership assets by $18,000. They haveshared profits and losses in the ratio of one-third to Artemis and two-thirds to Chan.If the partnership agreement states that a partner withdrawing from the firm will re-ceive assets equal to the book value of his owner’s equity, how much will Artemisreceive?

Chan will continue to operate the business as a proprietorship. What is Chan’s be-ginning capital on the proprietorship books?

Exercise 12-11 Withdrawal of a partner (Obj. 5)

Lana Brown is retiring from the partnership of Brown, Green, and White on May 31.The partner capital balances are Brown, $72,000; Green, $102,000; and White, $44,000.The partners agree to have the partnership assets revalued to current market values.The independent appraiser reports that the book value of the inventory should bedecreased by $16,000, and the book value of the land should be increased by $64,000.The partners agree to these revaluations. The profit-and-loss ratio has been 5:3:2for Brown, Green, and White, respectively. In retiring from the firm, Brown received$50,000 cash and a $50,000 note from the partnership.

Required

Journalize (a) the asset revaluations, and (b) Brown’s withdrawal from the firm.

Exercise 12-12 Liquidation of a partnership (Obj. 6)

Marsh, Ng, and Orsulak are liquidating their partnership. Before selling the noncashassets and paying the liabilities, the capital balances are Marsh, $25,000; Ng, $15,000;and Orsulak, $10,000. The partnership agreement divides profits and losses equally.

Required

1. After selling the noncash assets and paying the liabilities, suppose the partner-ship has cash of $50,000. How much cash will each partner receive in finalliquidation?

2. After selling the noncash assets and paying the liabilities, suppose the partner-ship has cash of $44,000. How much cash will each partner receive in finalliquidation?



Prior to liquidation, the accounting records of Pratt, Qualls, and Ramirez includedthe following balances and profit-and-loss-sharing percentages:

CapitalNoncash Pratt Qualls Ramirez

Cash + Assets = Liabilities + (40%) + (30%) + (30%)

Balances beforesale of assets $10,000 $57,000 $21,000 $20,000 $15,000 $11,000

The partnership sold the noncash assets for $73,000, paid the liabilities, and dis-bursed the remaining cash to the partners. Complete the summary of transactionsin the liquidation of the partnership. Use the format illustrated in Exhibit 12-4.


The partnership of Lee, Massé, and Nix is dissolving. Business assets, liabilities,and partners’ capital balances prior to dissolution follow. The partners share prof-its and losses as follows: Cory Lee, 25 percent; Sandra Massé, 55 percent; and ClydeNix, 20 percent.

Required

Create a spreadsheet or solve manually—as directed by your instructor—to showthe ending balances in all accounts after the noncash assets are sold for $272,000and for $180,000. Determine the unknown amounts, represented by (?):

A B C D E F1 Lee, Massé, and Nix2 Sale of Noncash Assets3 (For $272,000)4 Cory Sandra Clyde5 Noncash Lee, Massé, Nix,6 Cash Assets Liabilities Capital Capital Capital78 $ 12,000 $252,000 $154,000 $24,000 $74,000 $12,0009 272,000 ( 252,000) ? † ? ?1011 $284,000 $ 0 $154,000 $ ? $ ? $ ?1213 † ($A9 – $B8)*.2514 (For $180,000)1516 Cory Sandra Clyde17 Noncash Lee, Massé, Nix,18 Cash Assets Liabilities Capital Capital Capital1920 $ 12,000 $252,000 $154,000 $24,000 $74,000 $12,00021 180,000 ( 252,000) ? ** ? ?2223 $192,000 $ 0 $154,000 $ ? $ ? $ ?24

** ($A21 – $B20)*.25

Identify two ways the partners can deal with the negative ending balance in Nix’scapital account.


Challenge ExerciseExercise 12-15 Preparing a partnership balance sheet (Obj. 7)

On October 31, 2003, Jill Mathers and Don Smith agree to combine their pro-prietorships as a partnership. Their balance sheets on October 31 are as follows:

Mathers’ Business Smith’s Business

Book Current Book CurrentAssets Value Market Value Value Market Value

Cash........................................... $ 6,000 $ 6,000 $ 5,000 $ 5,000Accounts receivable (net) ....... 22,000 20,000 8,000 7,000Inventory .................................. 51,000 46,000 34,000 36,000Capital assets (net) .................. 122,000 105,000 54,000 60,000Total assets................................ $201,000 $177,000 $101,000 $108,000

Liabilities and Capital

Accounts payable .................... $ 24,000 $ 24,000 $ 10,000 $ 10,000Accrued expenses payable..... 2,000 2,000 2,000 2,000Notes payable .......................... 55,000 55,000Jill Mathers, capital ................. 120,000 96,000Don Smith, capital ................... 89,000 96,000Total liabilities and capital ..... $201,000 $177,000 $101,000 $108,000

Required

Prepare the partnership balance sheet at October 31, 2003.

Beyond the NumbersBeyond the Numbers 12–1 Partnership issues (Obj. 1, 5)

The following questions relate to issues faced by partnerships.

1. The text suggests that a written partnership agreement may be drawn up betweenthe partners in a partnership. One benefit of an agreement is that it provides amechanism for resolving disputes between the partners. What are five areas ofdispute that might be resolved by a partnership agreement?

2. The statement has been made that “If you must take on a partner, make sure thepartner is richer than you are.’’ Why is this statement valid?

3. Desaulles, Howard & James is a partnership of lawyers. Howard is planning tomove to Australia. What are the options open to her to convert her share of thepartnership assets to cash?

Ethical IssueGail LaRue and Cindy Ng operate The Party Centre, a party supply store in Burnaby,British Columbia. The partners split profits and losses equally, and each takes an an-nual withdrawal of $80,000. To even out the workload, Ng does the buying andLaRue serves as the accountant. From time to time, they use small amounts of storemerchandise for personal use. In preparing for a large private party, LaRue tookengraved invitations, napkins, place mats, and other goods that cost $2,000. Sherecorded the transaction as follows:

Cost of Goods Sold............................................... $2,000Inventory ......................................................... $2,000


Required

1. How should LaRue have recorded this transaction?2. Discuss the ethical dimension of LaRue’s action.

Problems (Group A)Problem 12-1A Writing a partnership agreement (Obj. 1)

Maria Rotor and Marie Deslauriers are discussing the formation of a partnership toimport fabric. Rotor is especially artistic, so she will travel to Central America tobuy merchandise. Deslauriers is an excellent salesperson, and has already lined upseveral large stores to sell the fabric.

Required

Write a partnership agreement to cover all elements essential for the business tooperate smoothly. Make up names, amounts, profit-and-loss-sharing percentages,and so on as needed.

Problem 12-2A Investments by partners (Obj. 2, 7)

Jay Woeller and Claudette LeBlanc formed a partnership on March 15, 2003. Thepartners agreed to invest equal amounts of capital. Woeller invested his propri-etorship’s assets and liabilities (credit balances in parentheses):

Woeller’s CurrentBook Market Value Value

Accounts receivable.................................................................... $ 12,000) $12,000)Allowance for doubtful accounts ............................................. (1,000) (1,500)Inventory ..................................................................................... 44,000) 31,000)Prepaid expenses ........................................................................ 2,500) 2,500)Store equipment.......................................................................... 37,000) 27,000)Accumulated amortization ....................................................... (10,000) (-0-) )Accounts payable ....................................................................... (22,000) (22,000)

On March 15, LeBlanc invested cash in an amount equal to the current market value of Woeller’s partnership capital. The partners decided that Woeller wouldearn 70 percent of partnership profits because he would manage the business. LeBlancagreed to accept 30 percent of profits. During the period ended December 31, 2003,the partnership earned $90,000. LeBlanc’s withdrawals were $32,000 and Woeller’swithdrawals were $36,000.

Required

1. Journalize the partners’ initial investments.2. Prepare the partnership balance sheet immediately after its formation on March 15,

2003.3. Journalize the December 31, 2003, entries to close the Income Summary account

and the partner withdrawals accounts.

Problem 12-3A Admitting a new partner (Obj. 4)

Green Lake Resort is a partnership, and its owners are considering admitting GregRivers as a new partner. On July 31, 2003, the capital accounts of the three existingpartners and their shares of profits and losses are as follows:

Capital Profit-and-Loss Ratio

Ellen Urlang ................... $ 72,000 1/6Amy Sharp ..................... 96,000 1/3Robert Hayes ................. 132,000 1/2


Required

Journalize the admission of Rivers as a partner on July 31, 2003, for each of the fol-lowing independent situations.1. Rivers pays Hayes $75,000 cash to purchase one-half of Hayes’ interest.2. Rivers invests $75,000 in the partnership, acquiring a one-fifth interest in the

business.3. Rivers invests $60,000 in the partnership, acquiring a one-eighth interest in the

business.4. Rivers invests $45,000 in the partnership, acquiring a 15% interest in the business.

Problem 12-4A Computing partners’ shares of net income and net loss (Obj. 3, 7)

Robin Kantor, Kami Karlin, and Joe Schipper have formed a partnership. Kantorinvested $40,000, Karlin $80,000, and Schipper $120,000. Kantor will manage thestore, Karlin will work in the store three-quarters of the time, and Schipper willnot work in the business.

Required

1. Compute the partners’ shares of profits and losses under each of the followingplans:a. Net income is $174,000, and the partnership agreement does not specify how

profits and losses are shared.b. Net loss is $94,000, and the partnership agreement allocates 45 percent of prof-

its to Kantor, 35 percent to Karlin, and 20 percent to Schipper. The agreementdoes not discuss the sharing of losses.

c. Net income is $208,000. The first $100,000 is allocated based on “salaries” of$68,000 for Kantor and $32,000 for Karlin. The remainder is allocated based onpartners’ capital contributions.

d. Net income for the year is $182,000. The first $60,000 is allocated on the basis ofpartners’ capital contributions. The next $60,000 is based on service, with $40,000going to Kantor and $20,000 going to Karlin. Any remainder is shared equally.

2. Revenues for the year were $1,144,000 and expenses were $962,000. Under plan(d), prepare the partnership income statement for the year. Assume a year end ofSeptember 30, 2003.

3. How will what you have learned in this problem help you manage a partnership?

Problem 12-5A Recording changes in partnership capital (Obj. 4, 5)

Outdoor Equipment is a partnership owned by three individuals. The partnersshare profits and losses in the ratio of 30 percent to Jane Mutchler, 40 percent toJohn Voorhees, and 30 percent to Ivana Weill. At December 31, 2002, the firm has thefollowing balance sheet:

Cash ............................. $ 35,000 Total liabilities ................ $115,000Accounts receivable... $ 20,000

Less: Allowancefor uncollectibles .. 1,000 19,000

Inventory .................... 98,000 Jane Mutchler, capital.... 45,000Equipment .................. 150,000 John Voorhees, capital... 59,000

Less: Accumulated Ivana Weill, capital ........ 50,000amortization.......... 30,000 120,000 Total liabilities

Total assets.................. $272,000 and capital ................. $272,000

Jane Mutchler withdraws from the partnership on this date.


Required

Record Mutchler’s withdrawal from the partnership under the following plans:

1. Mutchler gives her interest in the business to Lynn Arturo, her cousin, with theconsent of Voorhees and Weill.

2. In personal transactions, Mutchler sells her equity in the partnership to MichelAndré and Steven Craig, who each pay Mutchler $20,000 for one-half of her in-terest. Voorhees and Weill agree to accept André and Craig as partners.

3. The partnership pays Mutchler cash of $5,000, and gives her a note payable forthe remainder of her book equity in settlement of her partnership interest.

4. Mutchler receives cash of $20,000 and a note for $30,000 from the partnership.5. The partners agree that the equipment is worth $200,000, and that accumulated

amortization should remain at $30,000. After the revaluation, the partnershipsettles with Mutchler by giving her cash of $10,000 and inventory for the re-mainder of her book equity.

Problem 12-6A Liquidation of a partnership (Obj. 6)

The partnership of Cheung, Kosse & Lufkin has experienced operating losses forthree consecutive years. The partners, who have shared profits and losses in theratio of Fran Cheung, 15 percent, Walt Kosse, 60 percent, and Emil Lufkin, 25 percent,are considering the liquidation of the business. They ask you to analyze the effectsof liquidation under various assumptions about the sale of the noncash assets. Theypresent the following condensed partnership balance sheet at December 31, 2002:

Cash..................................... $ 34,000 Liabilities........................... $126,000Noncash assets................... 306,000 Fran Cheung, capital ....... 48,000

Walt Kosse, capital........... 132,000Emil Lufkin, capital ......... 34,000Total liabilities

Total assets.......................... $340,000 and capital ................... $340,000

Required

1. Prepare a summary of liquidation transactions (as illustrated in the chapter) foreach of the following situations:a. The noncash assets are sold for $350,000.b. The noncash assets are sold for $282,000.

2. Make the journal entries to record the liquidation transactions in requirement1(b).

Problem 12-7A Liquidation of a partnership (Obj. 6)

Link Back to Chapter 4 (Closing Entries). RMG & Company is a partnership owned by S. Ryan, G. Morales, and D. Goldberg, who share profits and losses in the ratio of1:3:4. The adjusted trial balance of the partnership (in condensed form) at June 30, 2003, follows:

Required

1. Prepare the June 30, 2003, entries to close the revenue, expense, income sum-mary, and withdrawals accounts.

2. Using T-accounts, insert the opening capital balances in the partners’ capital ac-counts, post the closing entries to the capital accounts, and determine each part-ner’s ending capital balance.

3. The partnership liquidates on June 30, 2003, by selling the noncash assets for$150,000. Using the ending balances of the partners’ capital accounts, prepare asummary of liquidation transactions (as illustrated in Exhibit 12–4).


RMG & COMPANYAdjusted Trial Balance

June 30, 2003

Cash ............................................................ $ 36,000Noncash assets .......................................... 174,000Liabilities.................................................... $150,000S. Ryan, capital .......................................... 33,000G. Morales, capital .................................... 61,500D. Goldberg, capital.................................. 93,000S. Ryan, withdrawals ................................ 21,000G. Morales, withdrawals.......................... 52,500D. Goldberg, withdrawals ....................... 81,000Revenues .................................................... 162,000Expenses..................................................... 135,000Totals .......................................................... $499,500 $499,500

Problem 12-8A Accounting for partners’ investments; allocating profits and losses;accounting for the admission of a new partner; accounting for thewithdrawal of a partner; preparing a partnership balance sheet(Obj. 2, 3, 4, 5, 7)

2002June 10 Amie Dhal and Marie Sung have agreed to pool their assets and form a part-

nership to be called D&S Consulting. They agree to share all profits equally andmake the following initial investments:

Dhal Sung

Cash ................................................................. $10,000 $20,000Accounts receivable (net).............................. 22,000 18,000Office furniture............................................... 24,000 16,000

2003May 31 The partnership’s reported net income was $130,000 for the year ended May 31,

2003.

June 1 Dhal and Sung agree to accept Mark Mason into the partnership with a $120,000investment for 30% of the business. The partnership agreement is amended to pro-vide for the following sharing of profits and losses:

Dhal Sung Mason

Annual “salary”........................ $60,000 $80,000 $50,000Interest on investment ............. 10% 10% 10%Balance in ratio of ..................... 3 : 2 : 5

2004May 31 The partnership’s reported net income was $320,000.

Oct. 10 Dhal withdrew $56,000 cash from the partnership and Sung withdrew $38,000(Mason did not make any withdrawals).

2005May 31 The partnership’s reported net income was $120,000.

June 2 After a disagreement as to the directions in which the partnership should bemoving, Mason decided to withdraw from the partnership. The three partnersagreed that Mason could take cash of $200,000 in exchange for his equity in thepartnership.

Required

1. Journalize all of the transactions for the partnership.2. Prepare the partners’ equity section of the balance sheet as of June 2, 2005.


Problem 12-9A Accounting for partners’ investments; allocating profits and losses; ac-counting for the admission of a new partner; accounting for the liquidationof a partnership (Obj. 2, 3, 4, 5, 6)

Judy Chapin, Herb Nobes, and Jean Yee started a partnership to operate a man-agement consulting business. The partnership (CNY Partners) had the followingtransactions:

2002Jan. 2 Chapin, Nobes and Yee formed the partnership by signing an agreement that

stated that all profits will be shared in a 3:2:5 ratio and by making the followinginvestments:

Chapin Nobes Yee

Cash ......................................................... $ 2,000 $ 3,500 $11,500Accounts receivable (net)...................... 7,000 10,500 15,000Office furniture....................................... 0 5,500 0Computer equipment............................ 13,000 0 4,500

Dec. 31 The partnership reported net income of $21,000 for the year.

2003June 7 Chapin and Yee agreed that Nobes could sell his share of the partnership to

Andre Dawson for $31,000. The new partners agreed to keep the same profitsharing arrangement (3:2:5 for Chapin:Dawson:Yee).

Dec. 31 The partnership reported a net loss of $25,000 for the year.

2004Jan. 3 The partners agreed to liquidate the partnership. On this date the balance sheet

showed the following items:

Cash ............................................................................................ $ 6,500Accounts receivable ................................................................. 123,000Allowance for uncollectible accounts.................................... 6,000Office furniture ......................................................................... 30,000Computer equipment .............................................................. 75,000Accumulated amortization (total).......................................... 23,000Accounts payable ..................................................................... 137,000

The assets were sold for the following amounts:

Accounts receivable ................................................................. $60,000Office furniture ......................................................................... 32,500Computer equipment .............................................................. 45,000

Chapin and Dawson both have personal assets, but Yee does not.

Required

Journalize all of the transactions for the partnership.

Problems (Group B)Problem 12-1B Writing a partnership agreement (Obj. 1)

Mary Basdeo and Sue Keim are discussing the formation of a partnership to installpayroll accounting systems. Basdeo is skilled in systems design, and she is convincedthat her designs will draw large sales volumes. Keim is an excellent salesperson, andshe has already lined up several clients.

Required

Write a partnership agreement to cover all elements essential for the business tooperate smoothly. Make up names, amounts, profit-and-loss sharing percentages, andso on, as needed.


Problem 12-2B Investments by partners (Obj. 2, 7)

On June 30, 2003, Sean Russell and Chris Mak formed a partnership. The partnersagreed to invest equal amounts of capital. Mak invested his proprietorship’s assetsand liabilities (credit balances in parentheses).

On June 30, 2003, Russell invested cash in an amount equal to the current mar-ket value of Mak’s partnership capital. The partners decided that Mak would earntwo-thirds of partnership profits because he would manage the business. Russellagreed to accept one-third of profits. During the remainder of the year, the part-nership earned $105,000. Mak’s withdrawals were $40,000, and Russell’s with-drawals were $30,000.

Mak’s CurrentBook MarketValue Value

Accounts receivable .................................................................... $ 8,000) $ 8,000)Allowance for doubtful accounts.............................................. (-0-) ) (1,000)Inventory ...................................................................................... 22,000) 24,000)Prepaid expenses......................................................................... 2,000) 2,000)Office equipment......................................................................... 46,000) 28,000)Accumulated amortization—office equipment ...................... (16,000) (-0-) )Accounts payable ........................................................................ (20,000) (20,000)

Required

1. Journalize the partners’ initial investments.2. Prepare the partnership balance sheet immediately after its formation on

June 30, 2003.3. Journalize the December 31, 2003, entries to close the Income Summary account

and the partner withdrawals accounts.

Problem 12-3B Admitting a new partner (Obj. 4)

Hazelwood Consulting Associates is a partnership, and its owners are consideringadmitting Helen Oldham as a new partner. On March 31, 2003, the capital accountsof the three existing partners and their shares of profits and losses are as follows:

Capital Profit-and-Loss Ratio

Jim Zook.............................. $ 80,000 15%Richard Land ...................... 200,000 30%Jennifer Lim ........................ 320,000 55%

Required

Journalize the admission of Oldham as a partner on March 31, 2003, for each of thefollowing independent situations:

1. Oldham pays Lim $290,000 cash to purchase Lim’s interest in the partnership.2. Oldham invests $120,000 in the partnership, acquiring a one-sixth interest in the

business.3. Oldham invests $120,000 in the partnership, acquiring a one-fifth interest in the

business.4. Oldham invests $80,000 in the partnership, acquiring a 10% interest in the

business.

Problem 12-4B Computing partners’ shares of net income and net loss (Obj. 3, 7)

Larry Aplevich, Elinor Davis, and Paul Diehl have formed a partnership. Aplevichinvested $30,000, Davis $36,000, and Diehl $54,000. Aplevich will manage the store,Davis will work in the store half time, and Diehl will not work in the business.


Required

1. Compute the partners’ shares of profits and losses under each of the followingplans:a. Net loss is $85,800, and the partnership agreement does not specify how prof-

its and losses are shared.b. Net loss is $120,000, and the partnership agreement allocates 40 percent of

profits to Aplevich, 25 percent to Davis, and 35 percent to Diehl. The agreementdoes not discuss the sharing of losses.

c. Net income is $184,000. The first $80,000 is allocated based on “salaries,” withAplevich receiving $56,000 and Davis receiving $24,000. The remainder isallocated based on partner capital contributions.

d. Net income for the year is $360,000. The first $160,000 is allocated based on part-ner capital contributions. The next $72,000 is based on service, with Aplevichreceiving $56,000 and Davis receiving $16,000. Any remainder is shared equally.

2. Revenues for the year were $1,760,000 and expenses were $1,380,000. Under plan(d), prepare the partnership income statement for the year. Assume a January 31,2003 year end.

3. How will what you learned in this problem help you manage a partnership?

Problem 12-5B Recording changes in partnership capital (Obj. 4, 5)

Personal Finance Services is a partnership owned by three individuals. The partnersshare profits and losses in the ratio of 28 percent to Katherine Smythe, 38 percent toMax Dune, and 34 percent to Emily Hahn. At December 31, 2003, the firm has thefollowing balance sheet:

Cash.............................. $ 18,000 Total liabilities................. $ 97,500Accounts receivable ... $33,000

Less: Allowancefor uncollectibles .. 6,000 27,000 Katherine Smythe, capital 139,500

Building ....................... $465,000 Max Dune, capital .......... 75,000Less: Accumulated Emily Hahn, capital ....... 93,000

amortization ......... 105,000 360,000 Total liabilitiesTotal assets................... $405,000 and capital................... $405,000

Dune withdraws from the partnership on December 31, 2003, to establish his ownconsulting practice.

Required

Record Dune’s withdrawal from the partnership under the following plans:

1. Dune gives his interest in the business to Tony Dutoit, his nephew, with the con-sent of Smythe and Hahn.

2. In personal transactions, Dune sells his equity in the partnership to Bea Patelland Al Bruckner, who each pay Dune $75,000 for one-half of his interest. Smytheand Hahn agree to accept Patell and Bruckner as partners.

3. The partnership pays Dune cash of $22,500, and gives him a note payable forthe remainder of his book equity in settlement of his partnership interest.

4. Dune receives cash of $15,000 and a note for $105,000 from the partnership.

5. The partners agree that the building is worth only $420,000, and that its accu-mulated amortization should remain at $105,000. After the revaluation, the part-nership settles with Dune by giving him cash of $21,150 and a note payable forthe remainder of his book equity.


Problem 12-6B Liquidation of a partnership (Obj. 6)

The partnership of Amping, Blair, and Trippi has experienced operating losses forthree consecutive years. The partners, who have shared profits and losses in theratio of Denise Amping, 10 percent, Bert Blair, 30 percent, and Toni Trippi, 60 per-cent, are considering the liquidation of the business. They ask you to analyze the ef-fects of liquidation under various possibilities about the sale of the noncash assets.They present the following condensed partnership balance sheet at December 31,2002:

Cash.............................. $ 54,000 Liabilities...................................... $242,000Noncash assets............ 404,000 Denise Amping, capital.............. 62,000

Bert Blair, capital ......................... 78,000Toni Trippi, capital...................... 76,000

Total assets................... $458,000 Total liabilities and capital......... $458,000

Required

1. Prepare a summary of liquidation transactions (as illustrated in the chapter) foreach of the following situations:a. The noncash assets are sold for $424,000.b. The noncash assets are sold for $344,000.

2. Make the journal entries to record the liquidation transactions in requirement 1(b).

Problem 12-7B Liquidation of a partnership (Obj. 6)

Link Back to Chapter 4 (Closing Entries). BP&O is a partnership owned by B. Bell, S. Pastena, and C. O’Donnell, who share profits and losses in the ratio of 5:3:2.The adjusted trial balance of the partnership (in condensed form) at September 30,2003, follows:

BP&OAdjusted Trial BalanceSeptember 30, 2003

Cash ............................................................ $ 50,000Noncash assets .......................................... 177,000Liabilities.................................................... $145,000B. Bell, capital ............................................ 57,000S. Pastena, capital...................................... 44,000C. O’Donnell, capital ................................ 21,000B. Bell, withdrawals.................................. 45,000S. Pastena, withdrawals ........................... 37,000C. O’Donnell, withdrawals ...................... 18,000Revenues .................................................... 422,000Expenses..................................................... 362,000Totals .......................................................... $689,000 $689,000

Required

1. Prepare the September 30, 2003, entries to close the revenue, expense, incomesummary, and withdrawals accounts.

2. Using T-accounts, insert the opening capital balances in the partner capital ac-counts, post the closing entries to the capital accounts, and determine each part-ner’s ending capital balance.

3. The partnership liquidates on September 30, 2003, by selling the noncash assetsfor $132,000. Using the ending balances of the partners’ capital accounts, pre-pare a summary of liquidation transactions (as illustrated in Exhibit 12–4).


Problem 12-8B Accounting for partners’ investments; allocating profits and losses; ac-counting for the admission of a new partner; accounting for the with-drawal of a partner; preparing partnership balance sheet(Obj. 2, 3, 4, 5, 7)

2002June 10 Steven Dikolli and Sharon McCracken have agreed to pool their assets and form

a partnership to be called D&M Logistics. They agree to share all profits equallyand make the following initial investments:

Dikolli McCracken

Cash ................................................................. $14,000 $24,000Accounts receivable (net).............................. 28,000 14,000Office furniture (net) ..................................... 32,000 18,000

2003May 31 The partnership’s reported net income was $152,000 for the year ended May 31,

2003.June 1 Dikolli and McCracken agree to accept Myra Pinos into the partnership with a

$140,000 investment for 40% of the business. The partnership agreement isamended to provide for the following sharing of profits and losses:

Dikolli McCracken Pinos

Annual “salary”........................ $80,000 $60,000 $40,000Interest on investment ............. 10% 10% 10%Balance in ratio of ..................... 2 : 3 : 5

2004May 31 The partnership’s reported net income is $380,000.

Oct. 10 Dikolli withdrew $60,000 cash from the partnership and McCracken withdrew$40,000 (Pinos did not make any withdrawals).

2005May 31 The partnership’s reported net income is $150,000.

June 2 After a disagreement as to the directions in which the partnership should bemoving, Pinos decided to withdraw from the partnership. The three partnersagreed that Pinos could take cash of $340,000 in exchange for her equity in thepartnership.

Required

1. Journalize all of the transactions for the partnership.2. Prepare the partners’ equity section of the balance sheet as of June 2, 2005.

Problem 12-9B Accounting for partners’ investments; allocating profits and losses; ac-counting for the admission of a new partner; accounting for the liquidationof a partnership (Obj. 2, 3, 4, 5, 6)

William Press, Julie Harris, and Regina Visser started a partnership to operate acatering business. The partnership (PH&V Catering) had the following transactions:

2002Jan. 2 Press, Harris, and Visser formed the partnership by signing an agreement that

stated that all profits will be shared in a 2:3:5 ratio and by making the followinginvestments:

Press Harris Visser

Cash........................................................ $18,000 $12,000 $22,000Accounts receivable (net) .................... 30,000 22,000 90,000Office furniture (net) ............................ 0 0 22,000Catering equipment (net)................. 32,000 58,000 0

Dec. 31 The partnership reported net income of $80,000 for the year.


2003June 7 Press and Visser agreed that Harris could sell her share of the partnership to

Ray Ewing for $124,000. The new partners agreed to keep the same profit-sharingarrangement (2:3:5 for Press:Ewing:Visser).

Dec. 31 The partnership reported a net loss of $100,000 for the year.

2004Jan. 3 The partners agreed to liquidate the partnership. On this date the balance sheet

showed the following items:

Cash....................................................................................... $ 26,000Accounts receivable ............................................................ 474,000Allowance for uncollectible accounts .............................. 34,000Office furniture .................................................................... 112,000Catering equipment ............................................................ 360,000Accumulated amortization (total) .................................... 74,000Accounts payable ................................................................ 578,000

The assets were sold for the following amounts:

Accounts receivable ............................................................ $286,000Office furniture .................................................................... 124,000Catering equipment ............................................................ 160,000

Press and Ewing both have personal assets, but Visser does not.

Required

Journalize all of the transactions for the partnership.

Challenge ProblemsProblem 12-1C Deciding on a capital structure (Obj. 1, 2)

Rebecca Bernstein and Peter Tong have been in a partnership for five years. Theprincipal business of the partnership is systems design for financial institutions.Gross revenues have increased from $82,000 in 1998 to $935,000 in 2003, the year justended. The number of employees has increased from two in the first year to nine inthe most recent year. Bernstein and Tong realized that they had to build up thepartnership’s capital and have withdrawn only part of the annual profits. As a re-sult, their capital accounts have increased from $50,000 (Bernstein, $35,000; Tong,$15,000) in 1998 to $520,000 (Bernstein, $280,000; Tong, $240,000) in 2003.

The two partners realize that they must expand their capital base to expand theiroperations in order to meet the increasing demand for their systems designs. Atthe same time they wish to take personal advantage of the partnership’s earnings.They have been trying to determine whether they should continue the partnershipand borrow the necessary funds, take on one or more partners (several of their em-ployees have expressed interest and have capital to invest), or incorporate and sella portion of the business to outsiders. With respect to incorporation, Martin Askew,a former classmate of Bernstein’s who works for a stockbroker, has indicated heknows of investors who would be interested in buying a share of the business.

Required

Bernstein and Tong have come to you to ask for advice. In response to your ques-tions, they indicate they will need additional capital of $400,000 to $500,000.

Problem 12-2C The effects of accounting decisions on profits (Obj. 3)

Mary Antoine, Susan Chiu, and Alan May have been partners in a systems designbusiness for the past eight years. Antoine and May work full-time in the business;Chiu has a public accounting practice and works about five to ten hours per week


on the administrative side of the business. The business has been successful andthe partners are considering expansion.

The partnership agreement states that profits will be distributed as follows:

1. Partners will get 12 percent on their average capital balances. 2. Antoine will get a “salary” of $50,000; Chiu will get a “salary” of $6,250; May

will get a “salary” of $50,000.3. The balance remaining will be distributed on the basis of Antoine, 40 percent;

Chiu, 20 percent; and May, 40 percent.

The agreement also stipulates that the distributions outlined in parts 1 and 2 of theagreement will be made even if there are not sufficient profits and that any defi-ciency will be shared on the basis of part 3.

The capital structure was as follows at December 31, 2003:

Antoine....................................... $ 112,500Chiu ............................................ 687,500May............................................. 287,500Total ............................................ $1,087,500

There has been some stress in the partnership of late because Antoine believes thatshe is contributing a major part of the effort but is earning much less than May;Chiu is upset because she believes that she is earning the least even though hercapital is essentially funding the partnership.

Required

Mary Antoine, Susan Chiu, and Alan May have come to you to ask for advice as tohow they might amicably settle the present dispute. Assume net income in 2003was $262,500.


Extending Your KnowledgeDecision ProblemSettling disagreements among partners (Obj. 3)

Barbara Jevons invested $40,000 and Tara Schlee invested $20,000 in a public rela-tions firm that has operated for 10 years. Neither partner has made an additional in-vestment. They have shared profits and losses in the ratio of 2:1, which is the ratioof their investments in the business. Jevons manages the office, supervises the 16 employees, and does the accounting. Schlee, the moderator of a television talkshow, is responsible for marketing. Her high profile generates important revenue forthe business. During the year ended December 2003, the partnership earned netincome of $100,000, shared in the 2:1 ratio. On December 31, 2003, Jevons’s capitalbalance was $210,000 and Schlee’s capital balance was $140,000.

Required

Respond to each of the following situations:

1. What explains the difference between the ratio of partner capital balances atDecember 31, 2003, and the 2:1 ratio of partner investments and profit sharing?

2. Schlee believes the profit-and-loss-sharing ratio is unfair. She proposes a change,but Jevons insists on keeping the 2:1 ratio. What two factors may underlie Schlee’sunhappiness?

3. During January 2004, Jevons learned that revenues of $15,000 were omitted fromthe reported 2003 income. She brings this to Schlee’s attention, pointing out thather share of this added income is two-thirds, or $10,000 and Schlee’s share isone-third, or $5,000. Schlee believes they should share this added income basedon their capital balances: 60 percent (or $9,000) to Jevons, and 40 percent (or $6,000) to Schlee. Which partner is correct? Why?

4. Assume that an account payable of $12,000 for an operating expense in 2003 wasomitted from 2003 reported income. On what basis would the partners sharethis amount?

Financial Statement Problem

Fortin, Lin & Royce is a regional accounting firm with four offices. Summary datafrom the partnership’s annual report follow:

(Dollars in thousands,except where indicated) Years Ended June 30

2001 2000 1999 1998 1997

RevenuesAssurance services $1,234 $1,122 $1,064 $1,093 $1,070Consulting services 1,007 775 658 473 349Tax services 743 628 567 515 557Total Revenues $2,984 $2,525 $2,289 $2,081 $1,976Operating SummaryRevenues $2,984 $2,525 $2,289 $2,081 $1,976Personnel Costs 1,215 1,004 887 805 726Other Costs 712 630 517 458 415Income to Partners $1,057 $ 891 $ 885 $ 818 $ 835Statistical DataAverage Number of Partners 9 9 9 8 8

Required

1. What percentages of total revenues did FLB earn by performing assurance ser-vices (similar to audit), consulting services, and tax services during 1997? Whatwere the percentages in 2001? Which type of service grew the most from 1997 to2001?

2. Compute the average revenue per partner in 2001. Assume each partner works2,000 hours per year. On average, how much does each partner charge a client forone hour of time?

3. How much net income did each KPMG partner earn, on average, in 2001?s


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